In a recent Aberdeen Asset Management study conducted among 300 global financial decision-makers1, governance was found to be an integral factor when selecting and analysing investments. Almost 90% of respondents considered effective governance to be a critical driver of investment performance.
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 utilise 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 and globalised 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 globalisation 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. Instability and a sense of injustice can fuel dissent or worse, curtailing economic development, and in some cases, leading to more dramatic disruptions.
Environmental issues are increasingly a concern for investors, particularly relating to pollution, water stress, severe weather events and other effects of climate change. Some act as a constraint on corporate and national development, others add further costs to the system. Social risks, from the appropriate treatment of labour within the company and its supply chain, to relations with local communities, are also significant in many industries. It is perhaps not surprising, therefore, that a large majority (81%) of respondents expect their focus on risk management to increase over the next few years.
Good governance involves a qualitative, rather than mechanical, evaluation of corporate practices and of the people carrying them forward.
In this context, asset managers have a unique role as responsible stewards in the companies in which they invest. Fully 85% of the sample said asset managers should engage with the companies in which they invest client funds, both at the pre-investment due diligence phase and at regular intervals subsequently. It is disappointing, though, that a significant proportion of respondents (37%) believed, that asset managers were not adequately engaging with the companies in which they invested. Our industry needs to do more to demonstrate that it is adding value in this important way.
On the topics that should be addressed, an overwhelming majority favoured corporate governance standards (92%), with board diversity, structure and succession planning (83%) and corporate actions/takeovers (76%) also cited as important.
A defining feature of a sound governance model is a long-term perspective. Various studies have shown that investing over longer horizons benefits investors and society as a whole. This is a challenge when investors can be swayed by short-term rewards – which often come at the expense of long-term growth. The survey respondents highlighted barriers to implementing long-termism in practice, including regular peer group comparisons and regulation, particularly in relation to the three-yearly evaluation process for pension funds.
At Aberdeen, our global approach to investment is to think of ourselves as long-term owners of the business rather than short-term tenants of the shares. We resist the temptation to focus on ‘market noise’ and focus on each investment as if we were buying the entire company, making a long-term commitment to it. Our time horizon is aligned with those of the companies in which we invest, not with market trends. Good governance and stewardship are essential to our approach.
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.
As sources of strategic investment opportunity become more difficult to define and quantify, governance will play an increasingly important role as a key differentiator. This should be welcomed.
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.