About 90% of 300 global financial decision-makers surveyed in a recent Aberdeen Asset Management study considered effective governance to be a critical driver of investment performance.1
Governance, it seems, is viewed as an integral part to the investment process. That governance should lie at the heart of investment decision-making is not new. Less clear is the question of what defines good governance in today’s rapidly evolving world. Governance is not simply a box-ticking exercise of correct policies and procedures. Rather, it is a living, breathing process.
Understanding the people involved and the structures that they operate in is an important pre-requisite to an effective long-term investment approach.
Good governance involves a qualitative, rather than mechanical, evaluation of corporate practices and of the people carrying them forward. It evaluates complex issues like the quality of management, strategic direction, talent management, remuneration, culture and effective risk management.
In this sense, governance is more of an art than a science. While improvements in technology, communication and management information have aided the governance process, they are only useful when quality people utilize this information effectively.
A dynamic approach to governance is all the more important when one considers the global investment backdrop. We live in an increasingly interconnected global world in which political and economic developments in one country can have shockwaves on the other side of the planet within hours, or even minutes.
Macro events can strongly influence financial markets, and national governance has a direct impact on the way companies operate. These issues must be evaluated carefully in investment decision-making.
For several years, central bank intervention has acted as a buffer, protecting financial markets from geopolitical shocks. But increasingly, questions are being asked about the governance and accountability of central banks and regulators, questions that will only become more pertinent as the withdrawal of quantitative easing results in falling liquidity and heightened sensitivity of markets to further shocks.
While globalization has undoubtedly provided economic benefits to millions, it also brings with it new risks. Developing countries represent half of global gross domestic product (GDP), and yet unstable governance in some of these nations threatens to undermine their prospects, and those of companies and investors that have a stake in their future.
While globalization has undoubtedly provided economic benefits to millions, it also brings with it new risks.
Instability and a sense of injustice can fuel dissent or worse, curtail economic development. In some cases, it can lead to even more dramatic disruptions.
Environmental issues, for example, are increasingly a concern for investors. This is particularly related to pollution, water stress, severe weather events and other effects of climate change. Some of these issues can be a constraint on corporate and national development, while others add further costs to the system.
Social risks, such as the appropriate treatment of labor within the company, fairness with its supply chain, and relations with local communities, are also significant in many industries. It is not surprising, therefore, that a large majority (81%) of respondents expect their focus on risk management to increase over the next few years.
In this context, asset managers have a unique role as responsible stewards in the companies in which they invest. Of those polled, 85% said asset managers should engage with the companies in which they invest client funds, both at the pre-investment due diligence phase and subsequently at regular intervals. But 37% of respondents believed that asset managers were not adequately engaging with the companies in which they invested. This means the asset management industry needs to better demonstrate that it is adding value in this important way.
In a rapidly changing world, the need for well-governed institutions has never been greater. Good governance should not be an optional addition to a corporate strategy. Rather, it should be embedded in companies’ wider business and investment processes. Because with the new risks that exist in the investment world today, we may need some new rules.
1 The survey was conducted online from early September to early October 2015 and consisted of quantitative and qualitative questions. The sample group was 293 decision makers including pension fund trustees, financial directors, pension managers and consultants across the financial services industry and corporate and not-for-profits sectors.
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.