We have become so used to thinking about indexes, ETFs and beating the market that we have turned shares into financial commodities.
They have become building blocks with which we can synthesise ever more exotic instruments, but it has reached the stage where today the number of equity ETFs rivals that of the underlying equities. We have forgotten that within every index and behind each share price is a real company — a company that employs people, provides suppliers with livelihoods and customers with valuable goods and services.
It increasingly feels as if we understand the price of everything but the value of nothing. Advisers who bear in mind that equity investing is company ownership may be able to help their clients secure improved investment outcomes.
BACK TO BASICS
We need to go back to basics and remind ourselves what a "share" is — a piece of a real company, quite literally "our share." That share brings benefits, such as a claim on the company's net assets and a right to future distributions, but also responsibilities such as the duty to ensure the company is managed in a way that does not impair but rather enhances the sustainability of those benefits.
This is not only in the interest of the owner, who will enjoy an increase in value, but also for the employees, customers, suppliers and the community upon whose support the company relies.
This might sound like common sense, but in the quest to squeeze as much return as possible out of financial instruments, the belief that short-term profit maximization leads to the most efficient allocation of resources has become a dogma.
(More: Vanguard rolls out actively managed factor ETFs.)
Without an audible voice making the case for a more sustainable approach, company management teams have responded to the only signal heard: maximizing short-term profits by borrowing from the future. But not everything that counts can be counted, and the focus on squeezing maximum profit out of a company today often creates problems in the future.
Shortcuts create contingent liabilities that are often ignored by traditional financial reporting but can hurt shareholders when they become realized. Recent examples include falsified emissions statements, overpriced drugs or the promotion of "fake news." This brings all commerce into disrepute.
Thankfully something can be done. Company owners can engage and make the case for a more balanced approach to business that will lead to sustainable results. This will be to the benefit of the owner as well as other stakeholders upon whose support the company relies.
YOUR ESSENTIAL ROLE
Advisers have an essential role in making this happen by connecting asset-owning clients with active managers who engage with companies on their behalf. By doing this they will not only be contributing to a more sustainable outcome for the company — and thereby society — but they also will be accessing a source of underappreciated value that will enhance client outcomes.
By allocating capital to investment strategies that employ active engagement, the adviser will be helping the client to manage the longer-term risks that can arise from contingent liabilities. These may include issues relating to environmental, social and corporate governance factors (
ESG), which can help the client protect capital.
(More: Which investors are most attracted to ESG investments and why?)
Management teams that engage in more sustainable business practices may also create "contingent assets," and these may be hard to find in a balance sheet. Things like human capital, innovation and corporate culture can play a significant part in determining the path of a company's long-term financial results. However they can be hard to identify, can take time to become apparent and are often qualitative in nature.
If the adviser is astute at selecting active managers with the right philosophy and ownership mind-set, however, such contingent assets can be a valuable source of shareholder value creation.
Finally, such an approach is of increasing interest to clients. Those with longer-term investment objectives are uniquely placed to benefit from such an engaged approach to active ownership, since their time horizon matches the delivery of benefits from owning sustainable companies.
It also frequently matches their own objectives. Sustainable investing can bring alignment between the value they see in their investment portfolio and their own personal values.
Jeremy Richardson is a portfolio manager for RBC Global Opportunities Fund and other Global Equity portfolios at RBC Global Asset Management.
