Having invested in emerging and frontier markets for over 20 years, I have discovered there is a widely held view that corporate governance standards there are generally lower than those in the developed world. Many understandably assume that this is part of the reason why these markets are classified as “emerging”. Often these concerns discourage market participants from investing in the asset class at all. While I agree that standards can be dramatically improved (across both developing and developed markets), I believe that this deficiency presents an attractive investment opportunity.
In a blog at the end of last year, my colleague Greg Konieczny challenged investors to see themselves not as passive share “holders”, but as active share “owners”. At Mobius Capital Partners, we act as flag bearers for this cause. We are not discouraged when we encounter a company with a strong underlying business, but poor corporate governance. Instead, we try to understand whether the company’s board and management are interested in listening to our concerns and implementing a programme of reform. For this to be a success, it is paramount that all stakeholders display a willingness to address the deficiencies and not just pay lip service to the problem. As a result, engaging with management and understanding what truly drives them forms an integral part of our 4-6 week due diligence process before we invest in a stock.
We often find ourselves pushing at an open door, and this is particularly true of companies that have a strong controlling family stake. In these instances, our proposed changes are often championed internally by the second or third generation. These individuals have returned from Western business schools with an in-depth understanding of the procedures and transparency expected of a publicly listed company. They are hungry to make these improvements and act as the catalyst for change.
One of our holdings, a Turkish denim manufacturer, has already successfully introduced a long-term incentive program for executives based on share price performance and operating profit, aligning the interests of the founding family with those of the senior management and the minority shareholders. Our prior experience enabled us to propose a suitable structure.
At this stage you may be asking, why is strong corporate governance so important? One early benefit is that it demonstrates to the wider market the company’s intention to be perceived as a reputable. Often it reflects the start of an evolution from a domestic orientated firm to a more international player. More importantly, strong corporate governance creates a solid foundation on which wider operational as well as social and environmental improvements can be built. This can help us unlock further value within a business and drive a re-rating.
On the company level we believe an engagement approach based on partnership will play an increasingly important role in the future of active management. We do not wish to dictate to companies how to run their business, but instead help in creating the optimal conditions within which a company can realise its full potential and ensure a long term and sustainable outlook. This is reflected in our focus on ensuring companies have the appropriate board composition, introduce management incentive schemes and adopt best in class investor relations which includes best in class financial, social and environmental reporting.
There are signs that national governance is also improving on the macro level in some emerging markets. For example, China’s Securities Regulatory Commission has introduced voluntary environmental and social reporting guidelines for listed companies, which will be mandatory by the end of 2020. India’s Securities and Exchange Board has introduced new mandatory “business responsibility” reports for the country’s top 500 listed companies. They are expected, in time, to be applied to all Indian businesses. And after years of scandals South Korea’s Chaebols are coming under growing national, and international pressure to reform their antiquated corporate governance arrangements.
Corporate governance reform seems to be on the agenda in both emerging and “frontier” markets, and for good reason. The evidence reveals a strong link between corporate governance reform and improvements in financial performance. By integrating corporate governance, and environmental and social factors in our investment process, we can significantly reduce the risk profiles of our portfolios. This translates into higher risk-adjusted returns, and associated benefits for companies, all their stakeholders, and emerging markets as a whole.