Old hands or new brooms? Investing in different types of company management

Many company CEOs and boards of directors today are exposed to asymmetric profiles: they can achieve psychological and financial greatness if they succeed, but if they fail, their downside is limited with the company’s shareholders, employees and even customers bearing the economic pain. Just look at all the golden parachutes ‘failed’ management has received in recent years.

So how do you go about finding good management? After all, no investor – professional or otherwise - looks to invest in companies run by managers who are untrustworthy or poor stewards of their client’s capital (unless they are short-sellers looking to profit from falling share prices).

We decided to take a look at two extremes: managers looking for family-run companies or those with a long-standing CEO and managers looking for new management that can come in and turnaround the fortunes of a business.

Brown Advisory Global Leaders

The managers of Brown Advisory Global Leaders told us: “A recent study of the S&P 500 (an index of the largest 500 US-listed companies) showed that the median CEO tenure has declined to 5 years, which is less than an economic cycle and comes at a time when most investors are becoming increasingly short-term focused. This set up is diametrically opposed to our focus on long-term compounded returns.

“We prefer CEOs with long tenures, because they typically live and breathe their companies and frequently have significant emotional and financial skin in the game. In addition, long tenures enable us to effectively measure a manager’s ability to remain disciplined with free cash flow and balance sheet deployment. In this vein we have found that founders are frequently forces for good as either executives or directors.

“Our investments in Alphabet, Charles Schwab, Ctrip.com, CTS Eventim, HDFC Bank and Tencent are great examples of effective founder-backed businesses. In addition we have found that the presence of a founding family can be equally as powerful. As a result of our focus 37% of our companies have the founder of the founding families still involved in the business, and 40% of the remaining 63% of our companies are run by managers with over 10 year tenures.

Stewart Investors Asia Pacific Leaders

Stewart Investors Asia Pacific Leaders has a focus on family-run companies. Manager David Gait commented: “Asia is home to the world's greatest collection of good quality, listed, family-controlled companies. In fact, approximately two-thirds of listed Asian companies are controlled by families or their foundations. The opposite is true globally, with approximately two-thirds of listed companies having no identifiable long-term steward. Crucially, this prevalence of family-controlled companies is not limited to one part of Asia. It applies equally from Sri Lanka to Singapore to South Korea. It is perhaps the one feature that binds all Asian markets together.”

David believes this matters for three reasons. “The first is that the best companies require the ability to take long-term decisions that may not generate returns for many years or even decades. Good quality companies can take a patient and measured approach. They are able to act patiently because they have patient owners. When all around are focused on next quarter's earnings and borrowing to buy back shares to meet management bonus hurdles, the ability to think and act long-term becomes a very valuable asset.

“As well as looking forward, another advantage of family companies is their ability to look backward, often a very long way. This is particularly useful when it comes to thinking about risk. The third advantage of family ownership for investors is less tangible but also important: it opens the door for meaningful dialogue and engagement between investors, company owners and managers. It is hard to partner ownerless companies. Investor engagement is most successful when it is based on genuine partnership. Engagement then becomes less about confrontation and more about cooperation and collaboration.”

When change is good

There are, of course, many caveats – not all good quality family stewards run good quality businesses and not all good quality businesses are family-run. It’s also true that not all CEOs can add value over the long-term, especially if companies are growing from a small start-up to a large multi-national. Different skills are required and not all CEOs have these wide skill sets.

A change of senior management at a company can sometimes be a blessing, especially if the prospect of a more efficient leader taking over a firm can make for the perfect turnaround situation and investment opportunity.

Waverton European Capital Growth

The managers of Waverton European Capital Growth believe that only a third of European companies are run for shareholders. As such, they ignore weaker businesses with poor corporate governance and focus on five key attributes: aligned interests, earnings visibility, pricing power, cash generation and return on capital. They like organic growth and dislike big acquisitions.
Companies within the portfolio do not immediately have to have all of the five key attributes. Indeed many of their best ideas come from companies which are in the early stages of reform and often a new management team will be a part of this.

Chris Garsten, co-manager of the fund gave us an example recently: “Ambu had a change of management. The company had disappointed and a lot of fund managers are shorting the stock. But I think that makes it interesting. Historically, the company made reusable endoscopes. But new technology means they are now making them disposable. This goes against current trends of recycling, but if you think about it, this is probably one product you don’t want to reuse! Using disposable endoscopes will cut infections, especially for very ill people who are more vulnerable to them. The new CEO has invested his own money in the company and I like it – the story has changed.”

Jupiter UK Special Situations

Ben Whitmore, manager of Jupiter UK Special Situations, is a value manager who aims to hold shares in out-of-favour and lowly-valued companies. However, rather unusually, he uses the concept of behavioural finance in his contrarian approach to investing. He says that frequent company meetings can introduce unintended risks because some CEOs emphasise the positive and downplay the negative and, in turn, fund managers tend to believe what they say to reinforce their own views on the company.

“To suppress this confirmatory bias (favouring information that confirms one’s own preconceptions) from entering his portfolio, Ben limits his meetings with companies to occasions when a there is a change of CEO, because he finds that the new CEO typically gives more balanced information on the company, rather than just emphasising the strengths.

An example of positive management change he gave us is BP: “The then Chairman Carl-Henric Svanberg – who took the helm in 2010 – managed to steer BP through one of the largest marine oil spills in history, despite having only been there for three months.

“BP had to change the way it operated post-disaster,” Ben said. “It sold off its complex assets and shrank the company to pay the bills. This left it (unintentionally) very well-positioned for the fall in the oil price. It also had a good growth path for the first time in 25 years.”

Carl-Henric Svanberg left BP in 2018 and is now current Chairman of Volvo. Helge Lund took his place as Chairman and the stock remains the largest holding in Jupiter UK Special Situations today*.

*Source: fund factsheet, September 2019

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the managers and the author and do not constitute financial advice.

Published on 19/11/2019