How engagement can boost returns

Man with roses © iStock
You may be less objective, but your heart will be in it

Many fund managers don’t believe in meeting the management of the firms they invest in. They argue that getting to know the people involved in running the business will make it harder to form an objective view of what it’s worth. However, others maintain that frank discussions with executives are the best way to make sure companies are being run for the benefit of all their shareholders – regardless of whether those firms are large or small.

Take the new Downing Strategic Micro-Cap Investment Trust (LSE: DSM), for example. This trust will follow the same strategy as Downing’s open-ended fund, which invests in micro-cap stocks that are often under-researched by analysts. This fund has produced a total return over five years of 134%, relative to 24% for the FTSE Small-Cap index.

The Downing team likes to get to know the management of companies before investing, as a form of due-diligence, says fund manager Judith MacKenzie. The fund operates a careful valuation process on potential investments, but she believes meeting the people involved helps, rather than hinders, the team in forming an opinion of a company’s potential. Generally, their involvement is well received, says MacKenzie. Good management teams with “nothing to hide” are often keen to work in partnership.

Meanwhile, the companies that don’t respond well to scrutiny tend to be the kind of business Downing won’t want to invest in – such as those where the management’s main focus seems to be paying themselves excessive salaries. In terms of the limits to what is productive, MacKenzie’s team draws the line at sitting on the boards of companies themselves. Instead, they prefer instead to “act as a dating agency” by suggesting possible board members and making introductions.

The Somerset Emerging Markets Dividend Growth Fund invests in more established, larger-cap companies than Downing, so manager Edward Lam focuses on bringing about improvements in corporate governance rather than shaping companies’ growth plans. Lam’s fund focuses on emerging-markets businesses with potential for dividend growth, with its largest allocations being to Korea, Taiwan and India. Since its inception in 2010, the fund has returned 65%, relative to 34% for the MSCI Emerging Markets index.

When Lam started his investment career at Lloyd George Management, the firm’s policy was to avoid voting on most corporate matters, in common with many fund managers at the time. These days he views actively engaging with companies in his portfolio as an important part of his role, citing actions such as persuading companies to change dividend policies or significantly altering the terms of corporate actions in favour of minority investors. In what he describes as “our most significant engagement to date”, Somerset objected to a proposed transaction between two South African-based firms – Shoprite, a supermarket chain that is one of Somerset’s investments, and Steinhoff, a furniture manufacturer and retailer that owns a number of global brands.

The deal involved an apparent conflict of interest and seemed more favourable to Steinhoff shareholders than Shoprite ones. Lam says Somerset was the only significant investor to object forcefully, with many other funds simply choosing to sell their holdings. He believes his team’s objections had a “pivotal, deal-busting impact”. Shoprite shares jumped by 8% on the day the deal was called off – and some investors who had sold out quietly began buying back in.

In the news this week…

• Shares in fund supermarket Hargreaves Lansdown (HL) fell by more than 8% on the news that American fund giant Vanguard is to launch a new, low-cost investment service, says Laura Suter in The Daily Telegraph. Vanguard announced on Tuesday that it is to launch its own platform where savers can manage their Isa and other accounts directly. The new service will charge 0.15% per year on any assets held on the platform, with the fee capped at £375. This can be compared with HL’s 0.45% charges on assets up to £250,000. Vanguard’s fund charges also “painfully undercut” rivals, notes Suter.

• Investment manager Ruffer has been steadily buying up derivative contracts that would pay out if volatility jumps – such as in the event of a large drop in the US market – according to people who are “familiar with the trades”, reports the Financial Times.

For several months, the identity of a mystery buyer of millions of dollars of insurance against a market meltdown has “consumed” Wall Street traders. Because the investor targeted contracts priced at half a dollar, the person was given the nickname “50 Cent”, after the US rapper known for his album Get Rich or Die Tryin’. It is thought that a single buyer is behind the purchases, based on the unusual pattern of buying options that always cost around $0.50.

Activist watch

Greenlight Capital, the activist fund run by David Einhorn, has written to shareholders of carmaker General Motors (GM) “highlighting the gap between GM’s stagnant share price and its intrinsic value”, reports Reuters. The hedge fund is pushing for GM to split its stock into two classes, with one paying higher dividends, and has put forward three nominees for the board.

“We don’t see why GM should sit by complacently with an inefficient capital structure while shareholders suffer,” said Einhorn in a recent interview, quoted on Bloomberg. GM has called Einhorn’s proposal “a high-risk experiment in financial engineering that is not in the best interests of GM shareholders”.  Greenlight Capital owns 3.6% of GM.