The Edinburgh-based Janus Henderson Emerging Market Equities Team believes it is imperative to understand non-financial as well as financial risks to the companies they invest in. Glen Finegan, Head of Emerging Market Equities, explains that, while not managing an environmental, social and governance (ESG) investment strategy, the team finds certain factors particularly important when assessing the sustainability of a company.
One of the features of investing in emerging markets is a weak or sometimes non-existent rule of law. The minimal protections for foreign minority shareholders such as us mean that we are unlikely to be in a position to win compensation in, for example, a Russian or a Chinese court for the rights that we might expect in many developed markets. This makes the up-front assessment of quality the most important part of assessing companies in which to invest.
Assessing the sustainability of a business
A core determinant of our view of the quality of a business is what we regard as the sustainability of a franchise. We believe that a business is either implicitly or explicitly granted a license to operate by all of its stakeholders – communities, employees, customers, shareholders and the government. In order for a company to have a sustainable business we believe the interests of all of these stakeholders, and environmental factors, have to be considered.
Look out for the warning signs
A company that dumps toxic waste in a river, abuses its employees or has questionable governance is providing a warning sign that it may not sufficiently care about the long-term future of its business, which should be (but is often not) reflected in its valuation. A business that abuses its stakeholders for the sake of improving its returns will likely be caught out when customers or the government respond to these abuses resulting in profound damage to the economics of the business. Even if this does not happen, a business that is prepared to abuse one set of stakeholders will likely, in time, find a way to abuse us as shareholders given their primary interest would appear to be short-term gain for themselves.
What we look for
Taking this broad view of a company’s place in its social, commercial and physical environment leads to a different style of interaction with management, which we have found helps to build relationships as they understand that our interests are broader than simply trading pieces of paper. This also leads us to more unconventional sources of information on a company, such as non-governmental organisations (NGOs), whose unpopularity is often a sign of their credibility, or the news service RepRisk, which monitors negative news coverage.
We do not believe in a tick-box approach to sustainability because understanding ‘why’ can be as important as understanding ‘what’. Many companies are controlled either by an individual or by a group, such as a government or a family, but not all controlled companies are bad. For example, if a family is aligned with you as a shareholder and cares about its reputation, having a long-term steward behind a corporation can lead to a very stable business. This can lead to a management team with confidence in its backers, which allows the team to take brave decisions when others are fearful.
We also do not believe that there is such a thing as a perfect company and tend to look at the direction of travel rather than simply where a business is at a given moment in time. Where we like the underlying business but believe there are changes that would enhance shareholder value, we will engage personally with management to try and effect change. We do not lose sight of the fact that we are only minority investors and believe in building effective relationships with management based on mutual respect and a long-term investment horizon. We have also found that this kind of engagement helps to build conviction in the broader investment case as it can provide a way to see different sides of a management team.
ESG within our investment approach
The ESG aspects of our approach manifest themselves practically in all of the research that we carry out and meetings we conduct:
- Company Reports: each of our company reports will look at the company’s sustainability positioning, which in practice means assessing the company’s treatment of all stakeholders. We will typically consult RepRisk as well as other references including competitors, suppliers, peers, etc. The report will typically raise a number of areas that we should engage the company on.
- Company Meetings: for each meeting we typically prepare a number of key questions, which include those on the company’s ESG performance and typically cover incidents reported on through RepRisk or other sources. We also try to understand where responsibility for ESG-related decisions sits and the company’s attitude towards sustainability in its broadest sense. Areas for engagement from previous research will also typically be raised.
- Voting: we vote as a team for the shares we own in a company. Where a particular issue is raised as part of the voting process we will typically engage with the company to better understand the rationale if it is not apparent and seek to not just vote against it but discuss it in detail where we think the resolution is not in the interest of minority shareholders and ultimately our clients.
The impact of our research and company meetings has led to a strong record of engagement with companies over the past 12 months. Notable outcomes included engaging with the management team of Tiger Brands, a South African packaged goods company, on developing a change in the long-term incentive program better aligned with creating long-term shareholder value during a period of Chief Executive Officer transition.
Our approach is firmly based on understanding risks from every angle and using ESG-type criteria to assess these plays a key part in our approach to seeking long-term opportunities within emerging markets.
Note: The above stock examples are intended for illustrative purposes only and are not indicative of the historical or future performance of the strategy or the chances of success of any particular strategy. Janus Henderson Investors, one of its affiliated advisors, or its employees, may have a position mentioned in the securities mentioned in the report. References made to individual securities should not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security.