Evenlode Investment View - December 2015

PRINTER FRIENDLY VERSION

Stewardship & Engagement: A seasonal tale of cheer

At Evenlode we have an approach that involves investing in real life businesses for the long term. Regular readers of our views will have an idea of the type of business that we like to invest in. As it’s Christmas, with the New Year approaching, this is a natural point to lift our heads up and take a wider look around. In this view I’ll examine some of the broad issues and connotations of the long term approach. In particular, we have been working over the last couple of years to develop our interactions with companies and other investors. These activities fall under the moniker of ‘stewardship and engagement’. I have had the pleasure of leading this endeavour, working with investee firms and other investment businesses – and I have good news to report. As I sat down to pen a missive about the stewardship arena I found myself re-examining why we look for long term investments at all. I hope you won’t mind a quick recap before I deliver the good news story.

Why long term?

We look to invest for the long term for a number of different reasons that I split into three broad camps.

First, the investment case: We believe that value emerges from high quality businesses over the long term, so our investment time horizon must match that belief. Note that we are talking about high quality, not necessarily high growth, although the two may coincide. High growth can come with a high price combined with a high degree of uncertainty, not characteristics we look for. Good quality businesses develop their cash flows steadily over time, which is often not recognised by the market and so we can purchase (or own) them at any given point at an attractive price.

Second, the psychological case: market prices bounce around. As equity investors we can trade most securities at any given point in a trading day, and it would be easy to let our instincts (driven by greed and fear) take over and react to price moves. There is nothing wrong with trading per se, but if we believe that value outs in the long run rather than in the short term then we shouldn’t let daily moves of a few percentage points drown out our longer term ambitions. By starting off with a mindset that measures success over years rather than minutes, we have developed a process that reacts to long term value, not short term noise.

Third, the philosophical case: What are equity markets for? It’s often stated that they are a place where companies raise capital, which is true but only accounts for a tiny fraction of what happens. As economist and government adviser Professor John Kay notes in his most recent book Other People’s Money, the reality is that most trading happens between institutions, part of a development that he dubs ‘financialisation’. Much of this trading happens at frenetic pace. So what do equity markets do for the long term investor? They enable all of us to own companies, look after them and reap the benefits of the arrangement. Sometimes we get to buy at particularly attractive prices, and at the other end sometimes we get to sell. In between, we get to own businesses on behalf of both our clients and (as co-investors in the Evenlode fund) ourselves.  The market facilitates the process.

What does long term ownership imply?

That last point about owning and looking after is really key. By owning businesses we adopt a number of responsibilities. We need to ensure that a business continues to be managed in the best interests of shareholders, a task now known as stewardship. That statement has many facets; part of the current zeitgeist is, rightly, the impact of a business’s actions on wider society (think Starbucks and tax). In my view it is vital for the long term good of shareholders that a company look after the long term interests of other stakeholders, whether it’s employees, government, other taxpayers or society at large.

A company must have a sound strategy for executing its business. The early years of Evenlode were spent refining the identification of firms with defendable business models and sensible ideas for taking them forward. When we invest, one of the reasons we do so is because we think a company has those in place. But things can change. We continue to revisit our analysis, formally on an annual basis and in between times if circumstances dictate. If we see a development that we don’t like, what can we do?

The most immediate, and drastic, thing we can do is to sell the holding. However, we tend to reserve that for situations where there has been a fundamental change in the business model or the company’s balance sheet has become uncomfortably compromised, neither of which tends to happen very often. More often the development is subtler, a change in emphasis in a specific area perhaps related to strategy, capital allocation and/or remuneration policies. If this is the case, selling may be an overreaction. Then what should be done?

We should talk to the company concerned. First we need to understand the rationale behind the change. Perhaps it is sensible. If we think there are risks attached then we can let the company know. For specific points we can use the votes that we cast at general meetings on behalf of our unitholders to voice our views. That’s what engagement is about.

The really good news

I think the evolution of our stewardship activities is only right as the Evenlode fund has grown in size and it holds more meaningful stakes in firms on behalf of Evenlode’s investors. We haven’t just been engaging with our investees though. I have sat now in many forums and meetings alongside other investors, and the really good news is that we are not alone in developing our stewardship and engagement activities.

I am particularly indebted in this effort to the Corporate Reporting User’s Forum (www.cruf.com), which is kindly administered by PwC (other professional services firms are available). The CRUF’s focus is on promoting accurate and honest reporting, and the interaction of accounting standards with the story that is told to investors. I have witnessed the various rule and standard setting bodies (IASB, FRC, ESMA and so on) interacting with investors and analysts with the goal of making corporations more transparent and understandable to investors. Around the table have been representatives from major asset managers and independent firms such as ours. The CRUF being a body that looks to affect the rules, it might be regarded as the ‘stick’ part of the ‘carrot-stick complex’ of corporate improvement.

We have also recently joined The Investor Forum, which was set up last year in response to the above-mentioned John Kay’s governmental review into equity markets in 2012. The aim of The Investor Forum is to promote constructive interaction between companies and investors specifically on matters of long-term strategy. The positive approach combined with the stated aim of being low-profile might be considered the ‘carrot’ to corporates. Again, asset managers large and small are represented, and it is rather in a listed company’s interests to keep such a collection of owners’ representatives on board and on-side. This is a new development for us, and we look forward to working positively with the Forum in the coming years.

These are to name but two initiatives, and there are many more in the industry besides. Improving the communications from firms to investors and vice versa is one way of encouraging long-running dialogue, and thus long-term investment approaches. That applies at the investor level and in the internal investment decisions firms make themselves. It shows that the participants care about improving the thinking behind such decisions.

A common criticism of investment managers is that they are myopic, so caught up in their own short term performance targets (and perhaps their own career paths) that they ignore the bigger picture of long term investment. What I have witnessed is that, at least for a significant subset of professional investors, that view is simply not accurate.

Some cheer for the New Year

I’m afraid none of the above will eradicate investment mistakes, corporate failure, market volatility, the economic cycle, or make the future any easier to foretell. We will continue to look for investment candidates that fit our defined investment criteria, and with that approach we hope to do well for our co-investors in the long run.

Nor will it completely remove short-termism, but what my observations indicate is that, far from the negative picture that is often painted, the investment management profession is taking the criticisms levelled at it seriously, and is actively working to improve its societal impact through stewardship of companies and engagement across the broad swath of capital markets participants and regulators.

It is unlikely to ever be perfect, but the effort gives me some cheer going into the New Year. With that, I’d like to wish you a Merry Christmas from all of us at Evenlode and Wise Investment, and we look forward to continuing to work for our investors in 2016.

Ben Peters
Investment Director
December 2015

Please note, these views represent the personal opinions of Ben Peters as at 17th December 2015 and do not constitute investment advice.

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