By Richard Harwood CFA

Managing Director (Jersey) and Fund Manager

Investing, like many other aspects of the modern world, is changing rapidly to include softer considerations which would previously have been ignored, and the integrity of the senior management team is rapidly becoming an important factor for investors to consider. Corporate history has been full of powerful leaders whose power and influence has been largely unchecked by their Boards and fellow Directors and whilst some of these characters have been immensely successful, the drive necessary to achieve that often comes with less positive personal characteristics.

It is impossible to read any biography of the late Steve Jobs and not admire his vision and determination, but also to realise that his drive left a wake of carnage in both his personal and professional relationships and that some of his behaviour would not be tolerated in today’s society. More recently, Steve Wynn and Sir Phillip Green have been subject to public damnation which, in the case of Steve Wynn, resulted in his being ousted as CEO of the Company bearing his name, as well as being forced to sell his shares in that Company. The consequences have not been solely reserved for the individuals involved, with many of the Board Members who oversaw Steve Wynn’s tenure as CEO having stepped down under shareholder pressure as it became apparent that they had not fulfilling their duty in monitoring the activities of their CEO.

Whilst these instances are disappointing, is it really a matter of concern for investors?Unfortunately, the answer is very much yes. When the allegations against Steve Wynn surfaced, the Wynn share price stood at $200, whilst it now trades at $117 with question marks still hanging over whether the company will be stripped of its license to run the $2.5bn Boston Encore casino. In the four days after the news broke, investors lost around $4.2bn of value.

Consumers are also becoming increasingly intolerant of poor public behaviour, with certain consumers boycotting brands which fall below acceptable standards. Companies are now having to become much more aware of their public image than at any time in the past. There are still plenty of PR tricks which can change the public’s perception of a company’s brand, but in today’s increasingly transparent society, they are short term solutions to a long term problem.

The role of the Board, which was perhaps once seen as a reward for a lifetime of service, is changing. It is now incumbent upon Board Members to monitor and review the behaviour of overly powerful CEOs, not only for their own protection but to prevent potentially permanent damage to their company. The world is changing very rapidly, and it is important not to be on the wrong side of that changing trend. Thinking about the integrity of a company and its senior management is an important step for investors, in avoiding what can be very expensive mistakes.

This document has been issued by the MitonOptimal Group of companies. The content of this document is for information purposes only and does not constitute an offer or invitation to any person. The opinions contained in this document are subject to change and are not to be interpreted as investment advice. You should consult an adviser who will be able to provide appropriate advice that is based on your specific needs and circumstances. MitonOptimal‘s prior written consent must be obtained before the contents of this document are reproduced or communicated to any third party. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable and given in good faith, but no representation is made as to their accuracy, completeness or correctness. MitonOptimal’s respective directors, officers, employees and associates may have an interest in the products, services or service providers occasionally referred to herein. The value of investments and the income from them may vary, and you may realise less than the sum invested. Past performance is not necessarily a guide to future performance and no guarantees are offered in respect of investment returns and/or capital invested. MitonOptimal Portfolio Management (CI) Limited (Registration No. 36763) and MitonOptimal Guernsey Limited (Registration No. 40985) are both registered in the Bailiwick of Guernsey and licensed and regulated by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law 1987, as amended. MitonOptimal UK Limited is registered in England and Wales (Company No. 09138865). Authorised and regulated by the Financial Conduct Authority. MitonOptimal South Africa (Pty) Ltd (Registration No. 2005/032750/07) & MitonOptimal Portfolio Management (Pty) Limited (Registration No. 2000/000717/07) are regulated in South Africa by the Financial Sector Conduct Authority (FSCA). MitonOptimal South Africa (Pty) Limited (FSP No. 28160) and MitonOptimal Portfolio Management (Pty) Limited (FSP No. 734) are authorised Financial Services Provider’s (FSP’s). MitonOptimal South Africa (Pty) Ltd and MitonOptimal Portfolio Management (Pty) Limited comply with all the requirements of the Financial Advisory and Intermediary Services (FAIS) Act (Act 37 of 2002). MitonOptimal Jersey Limited is regulated by the Jersey Financial Services Commission (Company No. 97242). Full details on all companies within the MitonOptimal Group are available on our website (www.mitonoptimal.com).

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James Downie may well be the best asset consultant in SA He has an independent mindset and a wealth of knowledge. So I couldn’t ignore it when he weighed in on the active-versus-passive investing debate.

Veteran investor Charles Ellis told us at a recent “fireside chat” with my friend independent financial expert Candice Paine that index investors should never have been called “passive”. It is hard to feel positive about anyone who is described as passive and, in contrast, “active” has overwhelmingly positive associations. Ellis made a fortune as an active manager and he is now a prime mover of simply riding the growth in the market passively.

Downie says active investing is easy to define – it is the style of an investment manager that takes active bets away from a particular index, investing more in cheap shares and less in expensive shares through clever stock selection to beat the index.

Some investors don’t even consciously weigh their portfolios against the index, but operate on a “clean sheet” basis. And they work on the assumption that the market is irrational: there is often more psychology than mathematics in active management. Ellis jokes that fund managers used to beat the index more often in the 1960’s, when they were primarily liberal arts graduates, than they do now that most have finance qualifications.

Downie agrees with Ellis that “passive” implies that both, the investor and the investment manager are lying back and doing nothing, not even enjoying themselves.

But there is nothing passive about constructing an index-based portfolio.

An investor might want to track the US market, but how is this defined? Should investors track the bellwether Dow Jones, the broader S&P 500, the new-economy-focused Nasdaq or the widest of the major indices, the Wilshire 5000? Over one year there would have been a 5.3% return from the Dow – a poor benchmark, as it consists of just 30 equally weighted shares chosen by the editors of The Wall Street Journal to reflect the US economy. Yet it thumped the 2.7% from the Wilshire with its long tail of small caps. And over five years Nasdaq has been the best performer.

Even in SA there is a proliferation of indices. Should investors go for the all share index 40? This would be an active decision to ignore mid caps and small caps. Or the shareholder-weighted index (Swix), which down-weighs dual-listed shares; or the new Capped Swix, which has only one purpose – to reduce the benchmark weighting of Naspers?

Low-fee attraction

Downie says even the global indices give differing returns. He says the MSCI all country world has given a 5.5% return over five years and the FTSE all world 6.2%.

For many investors the attraction of index trackers is low fees. Yet there are passive institutional products in SA that charge 0.35%, an eye-watering amount for a passive fund.

Index tracking should start getting traction once investors can pay the five to eight basis points charged by global houses such as Vanguard and Black-Rock. Fidelity now offers passive products at zero fees, presumably as a kind of supermarket loss leader – clients may be enticed to use its active funds and retirement administration services.

It is true that index-tracking houses such as Sygnia and 10X offer a good deal, relative to the total cost of a stand-alone fund or even a mainstream umbrella fund. But know what you are buying: 10X follows a proprietary index, not the ones you have heard of.