Many people believe a financial plan is predominantly about the return on their investment portfolio.
The reality, however, is far more complex. A holistic financial plan should also incorporate estate planning, retirement strategies, personal insurance, loan advice and, importantly, risk management. Investment returns should always be considered in light of the risks taken to achieve them.
There is an increasing focus by investors on Environmental, Social and Governance (ESG) elements, which reflect an organisation’s culture, values and risk profile.
Evidence is building that these factors have a significant impact on financial returns. One of the risks we consider carefully when selecting investments for clients is the risk associated with the G pillar.
Governance encompasses the structures and processes by which an organisation operates, and the mechanisms in which it is held to account. It includes factors such as board composition, executive pay and incentives, anti-bribery and corruption policies, stakeholder communications, and regulatory compliance.
There have been numerous cases in recent years where poor governance has impacted investor wealth. Some examples include:
- An insider trading investigation by the Australian Securities and Investments Commission (ASIC) resulted in sanctions under the Corporations Act for the fund manager involved. In response, several investment platforms sold down the funds affected with no warning, locking in unexpected capital gains for clients, with adverse impacts on their tax positions
- The Juukan Caves incident at Rio Tinto, and the sexual misconduct case at AMP cost directors and executives their jobs, caused reputational impact and led to share price declines
- In a recent example, an investment manager altered its investment strategy at the expense of some shareholders and to the benefit of others, destroying trust in the manager’s integrity
- As part of our due diligence on a portfolio manager who had produced outstanding investment results, we found the company had had three board chairs in 18 months, with one of these under investigation for fraud, and the current chair a family member of the portfolio manager. This poorly structured and unstable board indicated a poor approach to governance.
Strong governance, on the other hand, incorporates ethical values, transparent fees and incentives, alignment with investors’ interests, a diverse and independent board, and open communication with stakeholders, especially during periods of market volatility.
Governance is an important part of due diligence on investment opportunities. It’s important to understand not only the fund manager’s own in-house governance standards, but also their focus on the governance of the companies in which they invest clients’ money.
This forms part of the work we do in the background to reduce risk for investors. An investment opportunity which provides reasonable investment returns but fails governance filters is too high risk for inclusion in our clients’ portfolios.