Willis Towers Watson Asset Managers Review

Recent scandals in both the corporate and the public sectors have highlighted the need for appropriate risk controls to ensure the sustainability and capital security of investments. Are there new steps that you think investors and fund managers should be taking, to avoid some of the losses that portfolios have recently experienced?

Andrew Davison, head: advice at OLD MUTUAL CORPORATE CONSULTANTS says the increased governance budget and focus of the management boards of umbrella funds relative to most stand-alone funds has enabled them to focus on other issues such as environmental, social and governance (ESG), and we expect this to gather momentum as sustainability increasingly forms a critical requirement for long-term investors.

“Umbrella funds have also used their gate-keeper status and size to negotiate lower asset management fees and pass these on to members. The significant rise of passive solutions is also expected to drive a shift to lower fees for both active and passive managers alike,” says Davison.

Andrew Canter, chief investment officer at FUTUREGROWTH ASSET MANAGEMENT says we have all learned that corporate oversight (e.g. governance) does not begin-and-end with the Board of Directors: It also requires a web of executives, insiders, auditors, regulators, journalists and -- most notably -- shareholders and lenders. These financiers are the linchpin in corporate oversight -- it is their (or their clients’) money!

“Broadly, financiers play the role of allocating capital in the economy to those enterprises which are sustainable, worthy of trust, and provide valuable services to all their stakeholders. Analysts can often identify problems if they get timely, complete and relevant information: Thus it is incumbent upon financiers to demand that market standards of information reporting and transparency are far more than merely sufficient. Investors should be engaged, analytical, and questioning -- and must be willing to form opinions and to exercise judgement about which firms deserve support, which boards and management teams must be buttressed, or which agents (e.g. auditors) must be replaced.

“Management is often conflicted, and it is clearly inadequate to rely on auditors (‘we just do the accounts’), ratings agents (‘we just assign a rating’), the JSE (‘we just provide a trading platform’), corporate secretaries (‘we just keep the minutes’), regulators (‘we find out too late’), or any other non-financier agent.

“Broadly, investors should now have learned that they cannot take governance for granted: A responsible investor embraces his duty to protect his clients and play his role in building a sustainable economy,” says Canter.

Natalie Phillips, SA head of institutional, INVESTEC ASSET MANAGEMENT says the company embraces the concept of active stewardship.

“The aim of our work is to preserve and grow the real purchasing power of the assets entrusted to us over the long term. In fulfilling this purpose we will assume a stewardship role, including the effective exercising of our clients’ ownership rights. We will monitor, evaluate, and if necessary, actively engage or withdraw investments with the aim of preserving or adding value to our clients’ portfolios.

“Our primary objective is to ensure that we allocate our clients’ capital as efficiently as possible; to preserve and grow their wealth over the long term. We therefore take an active and transparent approach to stewardship including engagement with the investments in our portfolios. We believe this benefits our clients and improves the broader environmental and social context in which we invest.

“We believe that active management delivers superior performance over time, particularly when it is supported by robust research and portfolio management. Our mandate is to build diversified portfolios for optimal risk reward.”

Phillips says the consideration of ESG factors is integrated in the company’s various investment philosophies and processes and embedded in each step of the investment process including universe screening, fundamental analysis, portfolio construction, engagement and reporting.

Karl Leinberger, chief investment officer at CORONATION FUND MANAGERS says there are many things that we have learnt from recent scandals in the industry, all of which will be used to bolster and improve our defences against frauds in the future. Sophisticated cases of fraud are always difficult to detect from the outside, and the next one will differ in material ways from the last.

“For this reason, we don’t believe there is a single defence or silver bullet that is impregnable. An investor’s best general defence is increased layers of scepticism

and the improved understanding of the ways in which bad actors can deceive governance structures.

“We have taken various steps to increase our own defences and have invested significantly in our own forensic skills. We have increased scrutiny of audit services (including the insistence of regular audit firm rotation) and audit responsibilities when shared across multiple audit firms.

“We have also increased scrutiny of cases where dominant individuals in an organisation perform an unusually wide range of functions and responsibilities,” says Leinberger.

Khaya Gobodo, MD at OLD MUTUAL INVESTMENT GROUP says: “I believe we need to go way beyond the obvious improvements in regulatory tools and much higher levels of engagement and activism by professional investors with companies and their respective boards”.

“Over the last five decades, the investment community has increasingly recognised the significant skill involved in evaluating a company’s future prospects, its valuation and its appropriateness for inclusion in a portfolio. Over that time, both academia and the profession have developed powerful explanatory models as well as analytical tools to bring to the task.

“Investment professionals will need to go on a journey to transfer that same skill to improve the quality and rigour of corporate governance evaluation and the potential risks associated with a catastrophic failure in that area. This will need to extend to the judgement required in the decision-making process, which entails the use of insights gleaned from incomplete information,” says Gobodo.

St John Bunkell, head of equities and Nafees Hossain portfolio manager & analyst at PRESCIENT INVESTMENT

MANAGEMENT say these issues have highlighted significant challenges to the independence of the auditing and consulting businesses within accounting firms. Investors and risk allocators have had to elevate their understanding of the potential impact of recent revelations on investment returns as a result of various types of risk profiling.

Asset managers require the ability to attribute the impact of potential changes in risk appetite. More governance needs to be exercised by the regulator to ensure sustainability and the capital security of investments. Financial and time penalties need to be enforced at a fund management level to ensure the integrity and credibility of research.

Dr Adrian Saville, chief executive officer of CANNON ASSET MANAGERS says history shows that these types of events and scandals will happen again. As much as we try to find new mechanisms to protect investors, three hundred years of capital market history tells us that these events are doomed to repeat.

“Moreover, despite efforts on the part of regulators, systemic risk is also more pronounced now than it has ever been. I would argue then that recent events are a clear reminder that investing starts not with reaching for returns, but rather with effective risk management.

Tshego Modise, head business development at AEON INVESTMENT MANAGEMENT says corporate governance needs to be more prominent across all key decision-making interactions. Integrity is no longer an assumption of fiduciary duties; it needs to be investigated to the same degree of a financial statement or even more. The fiduciary responsibility of directors, regardless whether executive or non-executive should not absolve responsibility of failures in corporate governance.

The failures in corporate South Africa are a crisis of ethical leadership. The investment community needs to learn to not only applaud leadership performance based on financial returns but emphasise performance or results which is aligned to ethical demonstrations of fairness, honesty, stewardship and advocacy leading to a normal and equal society.

Sandy McGregor, portfolio manager at ALLAN GRAY says it is an illusion to believe that we can avoid a repetition of recent scandals. The reality is that we are all like generals well prepared to fight the last war. In a rapidly evolving business system there is always the possibility of some new ingenious fraud or imprudence. Apart from danger signals, such as excessive leverage or poor cash flows, investors rarely have access to sufficient information to form a realistic judgement on corporate governance.

Non-executive directors and auditors depend on company insiders for information. Only persons with considerable knowledge of how a company operates will be able to effectively question this guidance; we need directors who have this competence. The obsession with independence is misguided. What we need is integrity and knowledge rather than independence. However the key systemic security is that unsustainable business strategies ultimately fail. It is the prospect of failure that keeps the system honest.

Investment always involves the risk of loss. Successful investment involves having more winners than losers.

Mark Appleton, head of multi asset and strategy at ASHBURTON INVESTMENTS says diversification within South African equities are a challenge within the context of a narrow universe of JSE-listed companies as well as the concentration in factors that drive equities (i.e. Interest rate sensitivity, currency, commodity prices), requiring more prudence in the selection of equities.

“Equity investors can benefit from adopting principles of credit investing which places more emphasis on financial analysis and the least risk approach to portfolio construction.

“The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs”, this Warren Buffet quote is a great reminder of what it means to be a fiduciary.”

Appletong says there needs to strong disincentives in place to deter potential offenders, as well as structures which incentivise whistleblowing. Lawmakers have historically been too soft on white collar criminals. Laws need to be tough enough, and harshly enforced so as to sufficiently dissuade potential wrongdoing.

“Additional accountability needs to be placed on auditing firms who sign off the financials of companies (this is a key input into most assessments of a company’s value). It is the regulators and oversight organisations, as well as the legislative environment that needs to provide investors with the necessary protection.

“Futhermore, we believe that ESG overlays will become increasingly common in the way in which mandates are specified.”

Rowan Williams-Short, head of fixed interest at VUNANI FUND MANAGERS says it is perfectly ordinary human behaviour to focus on recent scandals and large losses. The fact is that these are not new phenomena. Many listed companies have gone bankrupt - certainly not all through corporate malfeasance - and many more will. Reporting standards for listed companies have improved, but determined, bright, crooked minds are always a step ahead.

“As has always been the case, the surest protection is a well-diversified portfolio. Thorough analysis of financial statements and appraisals of management and management incentives lessen the chances of being wooed into bad investments but can’t eliminate the possibility.

“Current initiatives to dramatically improve investment relations and disclosure by public sector bond issuers are to be heartily applauded,” says Williams-Short.

Johan Gouws, head of institutional consulting at SASFIN WEALTH says review of their current stock screening processes, forensic capabilities and increased pressure on the JSE to step in on trading activities on a stock when necessary.

Fabian de Beer, director of investments at MERGENCE INVESTMENT MANAGERS says fund managers are not forensic accountants or auditors. Even forensic accountants and auditors tend to be brought in only after the event that triggered the need for their services. Fund managers rely on publically available and audited financial statements and reports, and related information, as a basis for their analysis and research. If these are fraudulent, or aspects of the company have been hidden or obscured, research would not necessarily pick up on these, especially if auditors who spend many hours reviewing and verifying company financial information and reports did not unearth anything.

“That said, the approach to company and related analysis and research certainly has to adapt and incorporate potential measures to identify risk factors that have been glossed over due to over-reliance on audited financial reports.”

De Beer says while a more thorough approach is not necessarily a catch-all, it would go some way to ensuring a more robust approach to company and related industry analysis and the imposition of a fairer risk premium in valuations.

Matt Brenzel, joint chief investment officer at CADIZ ASSET MANAGEMENT does not believe that there is universal buy-in to the principles of responsible investing by the local fund managers. ESG-oriented funds have gathered some $13-trillion of international investor funds, so they do attract attention. There is little doubt that deficiencies in E, S or G can have a serious impact on the underlying investment. And it’s not just equities that provide the best examples; bonds are just as exposed (think Nenegate). As with many newish products, there are mountains of research products and products available (for a fee). For smaller fund managers, cost is obviously an issue. Start by focusing on the G, as many of the E and S issues are the result of a deficient G. At its heart is a solid understanding of the investment target and questioning mind that does not necessarily accept an audit or management opinion.