19 minute read
ESG: Why Good Governance Works
Why Good Governance Works
Companies with strong, diverse boards and transparent accounting are proven to do better. Victoria Harris, of Devon Funds, explains why the G in ESG matters.
Advertisement
If you missed the memo about ESG in investing, you’re one of very few investors who have.
Environmental, social and governance (ESG) factors are being used more and more by investors to assess the sustainability and risk profile of companies. And a good G rating is fast becoming an indicator of solid and reliable companies with great returns. It’s worth thinking about, because ESG factors can dramatically affect a company’s financial performance and shareholder value, either in a positive or negative way.
What is the ‘G’ in ESG?
G stands for governance. Governance falls into ESG investing as the decisions and changes made to help create a ‘better’ company. This could be through the ethics of its board members, its diversity standards, the company culture, or the sustainability of its day-to-day operations. Governance covers pretty much everything about a company – a broad range of corporate activities including its board and management, as well as a company’s policies, standards, information disclosure, auditing and compliance. Yes, everything! For example, investors want to know that a company’s accounting is accurate and transparent, and that its business practices are ethical.
They also like to see policies that encourage shareholder engagement and they want to invest in companies with a board of directors that’s both accountable and diverse by gender, race, skills and experience.
What boards do
Every share market-listed company has to have a board of directors. A board is an elected group of directors that represents the interests of shareholders.
A board’s role is different to a the job of the chief executive officer (CEO). Both boards and CEOs make high-level decisions, but a board can choose (and fire) the CEO, approve sweeping policies and make major decisions. The board oversees the CEO and makes sure the company’s performance is strong and it’s profitable. The board usually only meets a few times a year to review how the company’s performing and makes plans for the future. On the other hand, the CEO makes decisions daily, carrying out the board’s directives.
As CEO, you’re in charge of developing and executing strategy, while the board is responsible for approving and advising you on it.
At some companies, the CEO sits on the board, sometimes even serving as chair. This is not the most appropriate form of good corporate governance because the lines are blurred.
Ideally, board and CEO roles are separated so there are clearly defined roles and the strategy is well executed. As an investor, you can screen for good governance practices, as you would for environmental and social factors.
Poor governance
What does poor governance look like? A poorly governed company could be one that’s involved in legally or ethically questionable practices, that opens itself up to bribery or corruption, or one that doesn’t adequately address long-term risks to its business, such as the risks presented by climate change. Just like environmental and social issues, corporate governance issues also regularly hit the headlines.
Take Volkswagen Group, a perfect example of the negative consequences that can stem from poor governance. It was revealed in 2015 that the company had cheated emissions tests on more than 10 million of its diesel cars.
Volkswagen had to pay billions of dollars in criminal and civil penalties related to the scandal, which had a significant impact on shareholders.
Even today, the company’s share price hasn’t fully recovered.
CEOs’ salaries under scrutiny
Senior executives’ pay and bonuses are set by boards, and this is a contentious issue, which often comes up for discussion. Regulators in many countries require publicly-traded companies to allow shareholders to vote on executive compensation packages. Certain compensation structures work against the long-term interest of shareholders.
Recently, Norway’s influential US$900 billion sovereign wealth fund announced it would focus on curbing excessively high executive salaries at its investee companies.
Diversity is profitable
Gender diversity and gender equity are other high-profile governance issues. Many institutional shareholders are demanding more women on corporate boards and in executive positions, and want to see equal pay and career prospects for women.
Research from Morgan Stanley shows that a better balance of men and women in the workplace can deliver returns with less volatility, meaning that gender diversity is actually profitable for companies and investors.
In New Zealand, corporate diversity is still lacking on most major company boards. Most are made up primarily of older white men, which is probably not reflective of the needs of the business. In 2022, New Zealand’s top 50 public companies (NZX 50) have an average of seven board members per company. The average representation of females is two, or in other words, 30 per cent of board directors are women.
Only five out of those 50 companies have majority female directors. It’s even worse when we look at company leadership. Only four companies in the NZX 50 are led by a woman – PushPay, Sky TV, Spark and, more recently, Auckland Airport. There are more CEOs called Peter than there are women!
Great governance
However, there are also some great governance stories in New Zealand. One is Auckland Airport. Despite having a tough couple of years financially, it’s a leader in corporate governance. Global research house MSCI says Auckland Airport “falls into the highest scoring range relative to global peers”. It went on to say that its governance practices are well aligned with investor interests. Not only does the company have a female CEO, it has majority female representation on its board. This is, unfortunately, unusual in New Zealand.
What is the ideal board?
The ideal board is one with:
• gender balance • a mix of independent and nonindependent directors • members from different backgrounds • a variety of ages • differing skills and expertise. A diverse board leads to a company making effective decisions, guidance, and risk management. Having a diverse board of directors is a key element to a company’s success.
There are far-reaching effects to good corporate governance. It fosters a culture of integrity and leads to a positive performing and sustainable business.
There have been many studies done that show a positive correlation between good governance and corporate performance, measured in both financial terms and nonfinancial metrics.
Investors have started noticing this correlation, too. Now, more than ever, they’re demanding better corporate governance from the companies they invest in.
‘We bought houses in Australia, NZ and the US’
Their first property investment was an accident, but now Vicki and Mark Lambert live the good life.
Dunedin couple Vicki and Mark Lambert fell into property investing by accident. Says Mark: “Out of the blue someone offered to buy our house in Noosa, where we were living, and we had to look for somewhere to live.” They had A$30,000 after the sale and soon found a block of nine units being split up. They saw the potential, says Mark. “I thought this could be our retirement fund, if we played it correctly, and suggested buying three.” Vicki was horrified and tried to talk him into buying just two, but their accountant said they could afford three – if they lived in one. So they bought all three for A$105,000 to A$120,000. They planned to sit back while the units went up in value over the next 20 years. But soon Australian property prices started to climb and their units went up about A$200,000 each. Mark realised no-one else had noticed the market turn. “We quickly asked the bank if we could borrow against our assets and they agreed.” They bought another unit for a steal, and sold it less than a year later for a A$100,000 profit. “That $100k cash in the bank was a light-bulb moment. Investing became a passion. We realised we could invest instead of working.” He gave up work immediately and talked Vicki into handing in her notice months later. The pair also bought a home for a good price and lived in it for a year before selling it for a reasonable return. They were feeling pretty happy with their investments, but the market had peaked. Mark told Vicki “this is the end of the line for Aussie investing”, and she suggested New Zealand. “My sister had a house in Dunedin that was cashflow-positive, something we’d never had in Australia,” she says. Mark went online and started seeing hundreds of homes in Dunedin that did generate cashflow, but were old and tired. He says: “We booked flights instantly and Vicki and I arrived in Dunedin a week later. We were very naïve, but timing and a bit of luck was on our side again.” Over six months, they bought 13 houses, all with borrowed money, and renovated them. Prices in Dunedin were climbing. “To our absolute joy, the properties all doubled in value in just over a year.”
As big as Texas
So, Mark researched other areas round the world where prices hadn’t gone up and found Texas in the US stood out, so they flew to Houston and built houses for sale. They built and sold five houses before realising the Texan lifestyle wasn’t for them, and came back to Dunedin. They built two houses on a site they’d bought with Vicki’s brother-in-law, finishing them just as the market crashed. “We sold one and Vicki and I moved into the other and lived there five years.” For the next two or three years, the pair took time out and travelled, before buying a 25-room block at a local hotel. They saw the potential to rent it out by the room. They turned it into two dwellings, one 11-bedroom and one 12-bedroom, converting 2 rooms into kitchen/laundries. The pair ran the business for about five years with amazing cashflow, but got tired of ‘mothering’ tenants, and sold it for a “very handsome gain”. “We realised we still needed income or else we were just eating up capital,” says Mark. So they bought a mix of commercial and residential properties in the city centre, renovated them and sold them after about three years for a good gain. Next came the “worst project of our lives”, says Mark, building new houses to rent out in Dunedin. Resource consent became a nightmare, with years of planning delays. “We decided enough was enough, and started to look towards retirement.” They have four houses and are building a house and flat in Queenstown. They’ll have the income from those, and their investments in managed property syndicates. When the build is finished, they’ll relax, travelling in their campervan. Mark says: “Investing has given us a life we could only dream of. Looking back, would we still do it again? Absolutely!”
‘I couldn’t buy a house, so I invested in shares’
Rather than taking on an eye-watering mortgage, Madden Burns started investing with online share-trading platform Stake.
We tend to think that stress is always a negative force in our lives – but a little stress can prompt us to make positive changes. When Madden Burns was feeling left behind as her friends all bought houses, she used that stress as motivation. She started putting money into the share market, teaching herself about investing and setting herself up for a more secure financial future. In 2020, when she was 28, Madden and her partner realised that the property market was out of reach. They live in Sydney, where the median house price is now over A$1.5 million (NZ$1.6 million). “We’d been saving for a deposit for a long time, and we had a big chunk of money. But we weren’t going to be able to crack the property market and buy anything we really wanted. “A lot of my friends were buying houses with eye-watering mortgages. I think home ownership is just culturally ingrained – taking on a debt that big would really scare me.” With a decent sum of money saved and a growing acceptance that she would be renting for the foreseeable future, Madden knew she needed to change her strategy. Term deposits weren’t keeping up with inflation, and she wanted to make her money work harder. She started thinking that perhaps her retirement fund could come from investing in shares rather than into a mortgage.
Cutting the fees
“When Covid hit, I started to look into it. I looked at the fees and I realised I could lessen those if I did it myself. “So, I decided to jump in and start slow. Stake has no brokerage fee on trades and the ability to buy fractional shares, so I was able to get a feel for it, buy little amounts of companies I knew, and hone my skills.” She began by investing in Uber, Atlassian and a company specialising in solar power. “I just had a go, and it paid off, but that was good timing, it wasn’t necessarily my expertise.” Encouraged by this early success, she did more research and learned about the benefits of exchange-traded funds (ETFs). She still owns her early investments, and continues to do a bit of stock-picking with individual US stocks, but puts most of her savings into ETFs. “I’m funnelling money into ETFs religiously now with every pay packet,” she says. “It helps me spread my risk and gives me a bit more safety for my retirement plan. I do still put money into my early shares, and I recently bought into Square and Salesforce.”
Passion for tech firms
Madden works in consulting, often with clients in the tech sector, so she’s biased towards investing in tech companies. She mainly invests using the platform, tracking her investments using Sharesight – although it’s a struggle not to look at her balance too often. “When the market goes through a correction it can be alarming, but I trust my long-term strategy, my research, and the fundamentals on which I’ve selected my portfolio. “I’m just trying to be really logical and less emotional about my money. “It doesn’t make sense from a financial perspective to buy a house; it makes much more sense to buy shares, but you have to wrap your head around it.” When she first started investing in shares, Madden was feeling anxious about her financial future.
Always a worrier
She’s still a little worried, because the worrying is part of who she is, but she does feel more confident that she’ll be able to retire in comfort, even if she never buys a house. “The most powerful thing about investing is it gives you control of your financial future. Getting started is the hardest part, then you are on your way to a better future. “I’m confident I still have plenty of time on my side to not have to worry about things in 30 to 40 years’ time.”
‘We bought a business to help out our family’
In a heart-warming story, the lives of three generations of Paul Blair’s family have been changed after they bought a childcare centre.
Paul Blair and his wife were both high-flying corporate businesspeople at the peak of their careers when they made some life choices some people would see as rather different. “Our middle son, Jamie, was diagnosed as autistic,” explains Blair, a former head of institutional banking for a big Australianowned bank. “Jamie is 18 and six foot three but marooned at about age four or five in his interests, for example, he still loves playing the Wiggles. “Well, we’re not going to get younger, so we thought we should figure out a business where Jamie will have some part of it and where his interests will be supported and accepted.” So, Blair left his job and his wife Jo, who used to be head of marketing for Fisher & Paykel, retrained as an early childhood education teacher so they could set up a childcare centre. First the pair tried to develop their own centre by renovating a heritage building, but the consent process defeated them. Eventually they realised it would probably be easier to buy an existing business, so they approached Barkers Business Brokerage and bought a large centre in the North Shore suburb of Northcross that had been operating for close on 20 years. “We bought it from the founders, who were in their 70s. He was a builder who built it, and she was an early childhood teacher who ran it.” At first, they just bought the business and leased the property, with a first right of refusal to buy the property if the owners decided to sell. Says Blair: “When the owners decided to sell, we exercised our first right of refusal and bought it just before Christmas last year.” They did the purchase as a family deal with Jo’s parents, who were of retirement age but still farming. “It was a not-so-subtle push by his daughter: ‘Dad, you love the farm but maybe you should have a bit more of a passive investment’,” he says. “This is a move towards him getting off from the farm and into a family-owned business. It’s still gives him an interest, but it’s just physically a bit easier.” It turned out to be a difficult time to take over a business, right at the start of the Covid pandemic, but they loved it. “We’re enjoying the fact that we are our own boss, and the children are great fun.” He says one of the advantages of childcare for an investor is that about half of the income for the centre comes from government funding. “It’s quite stable, but it’s a highly regulated industry and economies of scale really matter. That’s why we wanted a large centre, with an experienced manager. “It’s got a really good team of teachers and that’s important, because it’s a people business through and through.” When the manager left to have her own life change in the Far North, Blair stepped in as manager for a time, but he’s just appointed a new manager. “The concept was always to have it under management and go from there, but it’s been such a period of change for everyone, that it needed more hands-on work.” Jamie’s part of the team, too, on three days’ work experience a week. He helps assemble furniture, cleans the water fountain, and does odd jobs around the centre. Says Blair: “He came into the centre yesterday when there was a little fouryear-old dressed in an Emma Wiggle costume. Jamie just thought that was fantastic. The staff were delighted to see this big kid and this little kid dancing and singing ‘Fruit Salad, Yummy, Yummy!’.” Now the couple’s oldest son has left to study at Canterbury University, their youngest is 16 and Jamie’s 18. “It’s the best time for the next stage of life for us. It’s very rewarding. “Everyone has challenges, and this is just us thinking outside the box, how we can shape our family into this little life that we want to lead.”
Hayden Johnston turned a passion for Japanese boy racer cars into an investment portfolio.
The classic advice about investing is to buy what you know – and Hayden Johnston is putting that advice into practice. His specialist knowledge of the global car market and lifelong involvement in the industry means he has the insider advantage to invest in classic cars as a successful strategy. Cars are a family passion for Hayden, whose dad Peter Johnston rallied in Group B race cars across New Zealand.
Boyhood love affair
The younger Johnston started out as a spectator, but from the age of 13 he was codriving for his dad. His love for Japanese cars stems from that time, he explains. “I have a specific date range for the cars I buy: 1992 to 2000 Japanese classic cars. When I was young, they were the brand-new race cars of that day, in rally, circuit and drift. “I’ve had a lot of European cars over the years, but the Japanese cars were the ones I yearned to own.” Johnston joined his father, who owns Genuine Vehicle Imports (GVI,) one of New Zealand’s largest importers of used Japanese cars, and he’s now the chief executive of the business. He’s always kept a close eye on the market, and in 2014 he made his first move into investing in his favourite JDMs, as Japanese domestic market cars are known.
Skyline was a keeper
“The first car where I thought, ‘This one I’ve got to keep’ was the [Nissan] R33 GTR Skyline,” he says. “I was seeing the lift in prices, and I thought, ‘This could be a future little earner, but if I want one, I need to get in now’. “I bought five or six other JDM classics in 2014 – I wish I’d bought more!” He still owns the R33 GTR, which has appreciated dramatically, along with many other models, including a “very, very nice” Honda Civic Type R and a Honda Integra Type R, both of which have jumped up in value in the past two years. “These are cars that five years ago we used to buy for $8,000 and thrash at the racetrack. Now they’re worth $40,000-plus and only get driven on Sundays!” The trade in classic cars is bustling, says Hayden, with Kiwi scouts on the lookout for vehicles they can buy locally and ship to the US, Hong Kong, Thailand, and Canada.
Over-25s in demand
Demand for ’90s Japanese classics has shot up, because any car manufactured at least 25 years ago can be imported to the United States, which is normally tightly regulated. Johnston watches the market closely as part of his job, ready to pick up a car for himself when the price is right. “I’m always buying cars to sell, then handpicking really good ones to keep. “I’m on the hunt for a later-model version of the R34 GTR Skyline, but they’ve gone ballistic. Ten years ago, you could buy one for $50,000, and now they can go for as much as US$500,000 – even the most horrible one is knocking on $200,000.” Johnston believes Japanese classic vehicles are still a fantastic investment opportunity. Their popularity continues to rise among younger generations, fuelled by a burgeoning ‘JDM culture’ on social media.
Fans drop by
For now, Johnston has no plans to sell his cars, but every day he gets requests. Fans often stop by to admire the vehicles. Add their growing value to the fun of driving the cars, and this hobby is the perfect retirement fund for Johnston. He didn’t grow up knowing about investing in the share market and admits he doesn’t really trust other people with his money. But buying cars allows him to indulge his passion, take advantage of his insider expertise, and remain fully in charge of his investment. “With cars, you can see them, touch them, and drive them – so you get to enjoy them while they appreciate. “It’s not like buying Bitcoin and hoping you can do something with it. You can jump in, go for a fang, and really enjoy your investment.
“It’s true that you don’t get a dividend, but for me the dividend is not financial, it’s the enjoyment you get from driving them.”
