Three Aberdeen portfolio managers recently spoke on a panel at Aberdeen’s London Investment Conference on the role of corporate governance in their investment decision-making process.
The Aberdeen panelists were Head of Equities Devan Kaloo, Head of Private Equity Graham McDonald and Head of Global Developed Markets and LDI 1, Fixed Income Neil Murray. Here is a summary of the main points from the discussion.
The role of asset managers
A company’s shareholders tend to have the responsibility and vested interest to ensure that companies are being run in an appropriate manner, commented Mr. Kaloo. This is because they have the ability to vote on the shares that they own, which can directly influence company management. This would certainly apply to equity managers, who typically own many shares of a company’s stock.
A company’s shareholders tend to have the responsibility and vested interest to ensure that companies are being run in an appropriate manner.
More broadly, equity managers can also help set the price of capital by disciplining companies through the sale or purchase of shares. For example, if a company wants to make an ill-conceived acquisition and pay for it by shares, selling those ahead of the acquisition will push up the cost of the acquisition and make management think twice. Indeed, if the acquisition were material enough, shareholders could even vote against it.
Shareholders can also enforce their own rights and hold the board of directors at a company accountable by requiring management to exit or advocating for change if poor governance is demonstrated.
This process does not necessarily apply to fixed-income managers the same way, Mr. Murray said. The difference is that fixed-income managers don’t own parts of the company as a shareholder or equity manager would. Instead, fixed-income investors lend money to governments and companies so they can go about their business. But this doesn’t mean fixed-income managers don’t have an important role in shaping a company’s governance policies. Fixed-income investors have an important role in shaping governance policies because with better governance and controls comes a lower cost of borrowing. Fund managers may be able to influence companies to improve their governance standards, but they rarely have the same influence with governments.
It should also be noted that the governance process for private equity is slightly different from other asset classes, particularly where the investment is in funds rather than companies directly, Graham explained. Investors must spend considerable time and effort to understand each fund and its governance requirements.
What does good governance look like?
When looking at companies as potential investments, the quality of management is a key factor. This is especially true when it pertains to how management has performed throughout various business cycles and how they have treated shareholders in the past, Mr. Kaloo and his team believe.
One factor his team likes to monitor is the other investors in the company since they may bring their own risks as fellow owners. While there are other important business and financial metrics, the quality of a company’s people will ultimately determine the quality of its governance, Mr. Kaloo remarked at the panel discussion.
Prior to the Investment Conference, Aberdeen carried out some governance research, which found that 85% of respondents said asset managers should engage with the companies in which they invest client funds, both at the pre-investment due diligence stage and at regular intervals subsequently.
Another finding from the research was that only 43% of respondents said that their asset managers are effective at engaging with the companies in which they invest, with a considerable 37% indicating that they are not.
Mr. Kaloo responded to these findings by saying that asset managers don’t engage with companies sufficiently as an industry. Engagement can be increased by carrying out governance checks and meeting privately with the company’s board and management.
Many investors are also taking governance responsibility upon themselves. Today, more and more global investors have their own requirements for environmental, social and governance (ESG) investing, said Mr. Murray. In fixed income, these requirements can be carried out in a manager’s research and screening process when looking for assets.
In private equity strategies, investors have become more selective in areas they don’t want to be invested in, said Mr. McDonald. These include ammunitions, nuclear weapons and alcohol production. There is now greater transparency around these issues. Many investors today have become better informed than they’ve been in the past, which can help with day-to-day decision-making.
An increasingly intermediated world
While the world for portfolio managers has undoubtedly become much more complicated in that there are more interest groups (from regulators to governments to civil society), some things have not changed. Portfolio managers are responsible for ensuring the companies they invest in are well run. The governance process may be more complicated than it used to be in that more people want to influence it, but it is still essential that companies ensure a good return on capital for investors.
1 Liability-driven investing
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).