Terry Smith on Corporate Governance

As you can see the same cannot be said for the major indices even though they have the benefit of including our good companies. The average year of foundation of our portfolio companies at the year- end was 1926. They are just under a century old collectively. Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth — high returns are not much use if the business is not able to grow and deploy more capital at these high rates. So how did our companies fare in that respect in 2020? The weighted average free cash flow (the cash the companies generate after paying for everything except the dividend, and our preferred measure) grew by 9% in 2020. The second leg of our strategy is to employ both negative Environmental, Social and Governance (‘ESG’) screening (not investing in high ESG risk sectors such as aerospace and defence, brewers, distillers and vintners, casinos and gaming, gas and electric utilities, metals and mining, oil, gas and consumable fuels, pornography and tobacco) and screening for sustainability in the widest sense, taking account of not only the companies’ ESG policies and practices but also their policies and practices on research and development, new product innovation, dividend payments and the adequacy and productivity of capital investment.each

However, in doing so, a lot of the actual net impact companies have is lost. Further issues that arise from this need for simplified ratings is that it forces asset managers to look for things they can measure accurately (board and employee diversity) or whether a company has a policy towards social issues such as animal testing, human rights or modern slavery. These are, of course, good things to have and are signs of good transparent corporate governance, but just because a company has a policy toward something doesn’t mean they actually behave in that way, and conversely, if they don’t have a policy, it doesn’t mean that they don’t behave in a way that we would approve of. A policy does not equate to action, and reducing a company’s net impacts on society down to a single metric overly simplifies the issue and too many of the good impacts that companies have are ignored or lost in the process. This leads onto the question of valuation. The weighted average free cash flow (‘FCF’) yield (the free cash flow generated by the companies divided by their market value) of the portfolio at the outset of the year was 3.3% and ended it at 2.9%, so they became more highly rated. Whilst this is a good thing from the viewpoint of the performance of their shares and the Fund, it makes us nervous as changes in valuation are finite and reversible, although it is hard to see the most likely source of such a reversal — a rise in interest rates — in the near future.

that comprise the median number are 18% and 26%. Nor is a mean (average) number much better as seven stocks in the portfolio have net cash on their balance sheets. The average year of foundation of our portfolio companies at the year end was 1933. Consistently high returns on capital are one sign we look for when seeking companies to invest in. Another is a source of growth — high returns are not much use if the business is not able to grow and deploy more capital at these high rates. So how did our companies fare in that respect in 2019? The weighted average free cash flow (the cash the companies generate after paying for everything except the dividend, and our preferred measure) grew by 9% in 2019. The second leg of our strategy is to employ both negative Environmental Social and Governance (‘ESG’) screening (not investing in high ESG risk sectors such as aerospace and defence, brewers, distillers and vintners, casinos and gaming, gas and electric utilities, metals and mining, oil, gas and consumable fuels, pornography and tobacco) and screening for sustainability in the widest sense, taking account not only the companies handling of ESG policies and practices but also their policies and practices on research and development, new product innovation, dividend payments and the adequacy and productivity of capital investment.

however, the CEO Mark Schneider should probably not be criticised for this as he is new in the role so he can’t be blamed for any past dilatoriness. To date Third Point’s approach to Nestlé has not lead to anything we are required to vote on which may be just as well. Procter & Gamble (‘P&G’) / Trian Trian is a fund run by Nelson Peltz whom I have already mentioned in the context of PepsiCo. Although we don’t directly have a dog in this particular fight, as we do not have any P&G in our portfolio, it still resides in our Investable Universe and so an investment is still regularly considered by us, and as we sold our stake because of concerns about P&G’s strategy we are interested in what Mr. Peltz had to say. Trian’s plan for P&G was detailed on 6th September. It called for ‘organizing P&G in a way that promotes accountability, faster decisions and responsiveness to local preferences’; ‘ensuring management’s $12–13bn productivity plan actually delivers’; ‘fixing the innovation machine’; ‘improving development of small, mid-size and local brands, both organically and through M&A’; ‘winning in digital’; ‘addressing P&G’s insular culture’; ‘improving corporate governance, including aligning management compensation with market share gains’. The page after these proposals—i.e. very much to the fore of the piece—details what Trian is ‘NOT’ (they wrote the word in capital letters) recommending.