Investors must eye governance
IN FOCUS: DAMAGE WHEN SAFEGUARDS FAIL
Environmental and social factors are also significant considerations to have an awareness of.
While investors tend to pay lip-service to environmental, social and governance (ESG) factors at the firms they invest in as long as returns are favourable, recent corporate scandals at Steinhoff and Tiger Brands have highlighted how serious the damage can be when safeguards fail.
Research by Bank of America Merrill Lynch shows that companies well-run from an ESG perspective typically have much lower drawdowns than companies that are not.
Alex Tedder, at Schroders, says it seems obvious that a well-run business would pay attention to ESG factors, but it’s not the way a lot of companies or investors think yet. “I think they will do, but it is at a very early stage.”
Facebook, which has an absolute weight of 2.3% in its Global Equity Alpha Fund, is a great company that has delivered fantastic returns for investors, Tedder says. “It offers a great growth profile [and] has a very strong franchise, but it is a company that actually has slightly problematic relationships with some of its stakeholders.”
Some key issues are how much responsibility a social network should have, given that it’s basically ungoverned, yet actively part of more than a billion people’s lives. There are also questions about Facebook’s political influence, whether it should be regulated and if certain individuals should not be allowed to use it.
While it explicitly scores ESG factors for the companies it invests in, Tedder says historically these factors have been underestimated by most.
“Now I think people are aware that it has a direct impact on a range of stakeholders but ultimately on you as a shareholder.”
The difficulty is that it’s very hard to know which companies have dubious compliance processes until there’s an event that demonstrates it.
While Tedder concedes Facebook is a high-risk stock, it also has “fabulous metrics”.
“From a financial standpoint and a return standpoint it has been a brilliant investment and that is what we do – we balance the risk and return.”
However, the risks – particularly regarding social and regulatory issues – seem to be weighing on sentiment. “We are becoming less confident about the holding because we think the risk of regulation is rising very rapidly.”
Tedder says ESG considerations can’t protect investors against corporate failures like Steinhoff as these events are difficult to predict. “If a manager is lying, it is very difficult to assess that and you’ll always have situations that you get wrong – every investor has that, but our view is that you have got to be systematic about it … [ESG considerations have] to be integrated into your process and there has to be a trade-off between risk and return.”
ESG considerations can assist to limit damage when an unfortunate event occurs, by restricting allocations to the stock. It may also offer an opportunity for fund managers to lobby management to improve practices. Where a company scores very negatively on one aspect of environmental, social or governance considerations, it’ll influence their decision to invest, Tedder says.