In a recent Aberdeen Asset Management study conducted among 300 global financial decision-makers, governance was found to be an integral factor when selecting and analysing investments. Almost 90 per cent 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 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.
Good governance involves a qualitative, rather than mechanical, evaluation of corporate practices and of the people carrying them forward. It evaluates complex issues as broad as the quality of management to effective risk management. It 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.
Globalisation has provided economic benefits to millions but has also brought new risks. Developing countries represent half of global GDP and yet unstable governance in some of these nations threatens to undermine their prospects, and those of the companies and investors that have a stake in their future.
Asset managers have a unique role as responsible stewards in the companies in which they invest. Some 85 per cent of those we surveyed 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 that a significant proportion of respondents (37 per cent) 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 per cent), with board diversity, structure and succession planning (83 per cent) and corporate actions/takeovers (76 per cent) also cited as important.
Environmental issues are increasingly a concern for investors. Some act as a constraint on corporate and national development, others add further costs to the system. Social risks, from the appropriate treatment of people within the company and its supply chain, to relations with local communities, are also significant in many industries. It is perhaps not surprising that a large majority (81 per cent) of respondents expect their focus on risk management to increase over the next few years.
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.