To begin with a simple statement, we aim to deliver compelling investment returns with relatively low turnover and volatility. We think of ourselves as 'owners' of equity stakes in each business as opposed to speculative investors. By this we mean that we expect our long-term investment returns to be driven by the compounding of operational cashflows, encompassing the normal "ups and downs" of the economic cycle. To achieve this we identify companies we believe are capable of sustained growth and sound capital-management on behalf of shareholders. There is a natural scarcity of such businesses, reflected in our focused, unconstrained portfolio construction.
We believe that attractive financial returns are only sustainable over the long-term if a company can successfully manage all aspects of good governance as well as the operational dynamics of their sector or industry. Factors under the "ESG" umbrella are integral to this assessment. We analyse both "direct" and "indirect" environmental and social factors affecting each of our invested companies, and look for evidence that each is being managed effectively. Crucially, we recognise that standards and expectations are evolving continually in these areas and management teams must display an adaptive and progressive approach beyond simple "box-ticking". Where this is lacking, businesses risk serious damage to their brand and "franchise" in an industry, and this will undermine the sustainability of returns we rely on as long-term investors. In terms of corporate governance we produce and maintain an extensive analysis based on multiple years of financial reports and accounts. Some of the key elements of this work include capital management, alignment of interest between management and shareholders and the performance of the board of directors.
We take an active roll in promoting socially responsible and ethical corporate governance in each of the companies which we invest in. Whilst we must be pragmatic, to a degree, about the differing "norms" in the developed and emerging markets in our investment universe, we ask all managements to be progressive in their policies, benchmark international best practice and seek to affiliate with relevant industry groups to drive standards. In addition to our signatory status under UNPRI, we incorporate the UK Stewardship Code of Practise to reflect the importance of responsible investing in our process.
The investment policy is set up as follows:
We look for businesses that have a strong position in a particular growth industry. These industries include areas such as internet services in China, regional life insurance and the growth of environmentally friendly technologies globally such as hybrid and electric components in the automotive market.
What we look for in a business
- Evidence of return as an indicator of franchise
- Unique industry position
- Large and exploitable long term opportunity
- Owner/manager alignment and integrit1y.
2.Owner due diligence
We view our investment in any company as ownership of that business. The question we ask is "if the stock market risked closing for ten years, would we be happy to own the equity position in question?". The work consists of the following analyses:
- The company's approach to corporate governance. We look in detail at shareholder and board structures, management compensation, related party transactions and conflicts of interest as well as employee compensation and pension provision. We also consider any sustainability reports produced by management and related statements under items related to "business risk".
- The environmental and social factors which the company faces. We categorise these under "direct" (ie the explicit result of manufacturing processes - eg mineral extraction - or the impact of a product on consumers or the environment) and "indirect" (ie damaging by-products of manufacturing - eg energy usage, air pollution - or impacts on workforce or the immediate social environment. We assess these factors based on how effectively each is managed against current best-practice and the ongoing evolution of company policies.
- The quality of the accounts: We adopt a forensic approach to analysing the company's accounting information, reviewing the last 5 years report and accounts as well as recent accounting policy announcements. This includes a review of assets and liabilities and the use of capital within the firm. For example,
- We regard management use of capital and their ability to create value for shareholders as a key barometer of governance. We closely examine and monitor changes in the capital structure and the deployment of capital to assess if management are deploying funds appropriately. This will include such things as charting a company's share issuance history, tabulating its M&A activity, assessing the price paid for assets and the goodwill created and trying to unravel whether past capital deployment has accrued reasonable returns.
- In addition many of the companies we invest in have large and complex group structures. We make efforts to understand where assets or liabilities are held and where returns or losses are being generated. We also assess the level of ownership and control over subsidiaries and affiliates, the level of any related party transactions and the extent to which tax planning may be taking place through the presence of subsidiaries and affiliates in low tax jurisdictions.
- Alignment with minority investors: If the business is controlled by the major equity holders (which is the norm in many Asian businesses), are the management's interests aligned with those of minority shareholders in terms of returns. We avoid companies where this is inequitable.
Our approach to valuation is based on the conservative extrapolation of cash-flow returns into the future, discounted by our own minimum required rate of investment return. This valuation is used as a reference to aid our judgement from a potential investment point of view rather than to provide a specific "price target".
- Value assessment is shaped by:
- Historic returns- what has been delivered?
- Franchise strength- Can it be sustained?
- Consider scenarios and risks, looking for asymmetry.
- Discount cash flows by our required rate of return.
- Classic "margin of safety" to allow for error.
We invest only in the equity of any business therefore there are no variations or exceptions in this approach.