Q2 2015 Stewardship Report

Quarter 2, 2015: Stewardship and Managing Equity Interests for Our Clients

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Old Mutual Global Investors manages money on behalf of its clients with the aim of generating returns to meet their financial aspirations.  As part of that process, we regard using our powers as shareholders, particularly the ability to engage with UK companies on a range of issues, as a key tool for relevant equity funds.  We are stewards of our clients’ interests and it is appropriate we report on that role.  This report is also consistent with fulfilling our obligations under the UK Stewardship Code 2012.

In these reports, it is generally our practice to remove identification of the companies with which we are engaging.  Experience has taught us that undertaking discussions which may be sensitive, or delicate, in the glare of publicity is damaging.  Publicity can cause a defensive reaction and entrench views.  We prefer to conduct a sensible dialogue with companies where, in the event of a change of policy, this can be adopted and not seen as a management climb down.  It is part of the need to build an element of trust, permitting clear and occasionally frank communication and challenge. 

Our voting policy document states that we control a wide range of equity interests.  These range from short-term holdings, in which case it is not appropriate to vote, to derivatives (which cannot be voted on) to funds where the focus is on trading.  Where our stewardship can be most effective, and where the bulk of our stewardship work will occur, is in long-only funds where the emphasis is on understanding and building a long-term investment and relationship with the company.

A sample of our activity for the April-June period of 2015 is set out below:

Slower Progress

We again met the chair of a company with whom we have been in regular contact for some years.  The company is undergoing a series of changes, including a high level of investment.  The discussions included: the rate of progress under their 5-year plan and fears that targets for completion may be missed; operational effectiveness; the role and performance of the CEO and the management structure; and customer segmentation and marketing. 

The chair has clearly identified actual and potential problems within the business, which in itself we deem positive.  These issues may, however, have increased the risk attached to the investment case for holding the shares. Nevertheless, the chair has, in the past, demonstrated an ability to initiate positive change within the business. 

Sustainable sourcing

We noticed a press announcement by a special interest group criticising a number of companies on their practice and disclosure list regarding farm animal welfare.  We contacted one of the companies listed, where we have a material percentage holding, to explore the matter further.  Our understanding was that their processes were sound.

The company explained that they believed the poor showing in the survey was due to previously limited disclosure of policies and practice.  We were assured that the company has procedures in place, but that these have yet to be put into a formal policy.  The company has recently increased disclosure and is, in any event, reviewing group sustainable sourcing policies as part of a move to improve efficiency in supply.  These will be disclosed within the next few months. 

Pay increase?

We were consulted by the chair of a company regarding pressure to increase the salary of a CEO.  The company has expanded, partly through acquisition, and comparative data clearly indicated that the CEO had fallen behind the peer group on salary. 

Given that salaries for CEOs are, in practice, correlated with the size of a company – the bigger the company, the higher the salary – so an acquisition of another business by any company will increase the size and, other things being equal, so the CEO’s salary will therefore fall behind that of the new, larger comparators.

We believe that there is a good management team at the company and we support them.  However, as investors, we need to be sure that acquisitions work – that the company has not overpaid, that targets are met and that the integration process has been successful – before any salary and other financial reward is allocated.  The chair of the company   anticipated our answer and was able to confirm this was also the view of shareholders in discussions with the CEO.  There remain some differences regarding the timing over which growth, including acquisitions, should be proven.  We see it as being in the interests of our clients to see improvement sustained over a number of years.  The chair prefers one year.  It is a subject for discussion over the coming months. 

Safety First

 Last year we reported that we understood from the chair that a mining company had conducted 20,000 breathalyser tests on its miners during the year. This was incorrect reporting on our part. .  The 20,000 tests per day are carried out as miners go into and out of the mines.  Anyone failing a test is dismissed.  As noted last year, the tests are conducted because the company has acquired mines formerly owned, and run, by governments under which, there had been no investment in process, people or systems for decades.  As a result the company had to impose strict measures in order to bring the mines up to modern standards.  As the chair noted, once anyone steps on to the company’s property, a different mindset is required whereby there is an intolerance of any breach of safety practices and procedures.  The board continues to regard safety as a priority issue and investigates each fatality. 

It is an example of the thorough approach the company takes to running its operations.  We concede that with respect to operational controls, the company runs them well.

Change

There were further discussions with a company following a change of CEO.  The appointment is regarded as positive.  The company also announced potential changes to its portfolio and strategy, both of which have been discussed with the company in recent months. 

Stranded Assets

We took the opportunity of a meeting with the chair of a mining company to raise the subject of stranded assets, namely that if the world is to stay below 2ºC of warming from anthropological climate change, then approximately 80% of identified fossil fuels must remain unburnt.  The chair of the company takes the view that the concept of stranded assets is weak, except perhaps in respect of coal in the US.  The argument against is based on the demand for power in emerging economies.  These economies are under political pressure to provide power, and therefore, improved living standards.  Coal in India and Indonesia, for example, provides by far the cheapest method of proving electricity, notwithstanding the fall in the price of renewables.  Coal also remains cheaper than gas after taking into account transport costs.  Therefore, demand for fossil fuels remains and governments will be reluctant to enforce international agreements to limit carbon emissions. 

Sadly, we suspect we have to agree.

Strategy

After a series of disappointments on the progress r of a turnaround plan, we explored with a company whether it would evaluate potentially merging with a competitor, given pressures in their market. 

Discussions will continue. 

Update

We met the recently appointed chair of a company.  The individual was known to us, having been an executive and chair of other companies. 

Discussions included observations on the executive team, succession planning for the executives, regulation, the strategy and the portfolio of businesses: this included discussion on the integration of a recent acquisition. .We also covered succession planning for the board generally and were pleased to confirm that the chair welcomes diversity on the board. They are shortly expected to announce that a strong female candidate will be joining the board. 

New chair

We accepted an opportunity to meet the new chair of a small company.  When it had been announced that the company would be seeking a new chair, we spoke with the board member responsible for leading the process, the senior independent director, about the process and the type of individual the board intended to recruit. 

The new chair has a good track record of managing large companies.  We were interested to learn why he might now join a small company.  He noted that the company was in a sector of which he did not have experience – but other members of the board do – and welcomed the opportunity to be able to mentor a highly competent chief executive.  The sector is likely to continue to change significantly and he sees opportunities to use his experience of change in another sector to assist the board and the company. 

We regard his appointment as positive.

Remuneration consultations

We were consulted by a number of companies regarding obtaining shareholder approval for annual remuneration reports, pay policy and share incentive schemes. 

These included a company seeking the consent of shareholders to amend the pay arrangements of a new executive.  It is common practice that executives joining from another firm will receive share awards that compensate the executives for lost bonuses and share awards on leaving their previous employer.  At this company, the executive had joined and received a compensatory set of awards but shortly after joining, the company declared a series of profit warnings that reduced both the share price and the value of the new executive’s awards.  It is understood that while the individual had not complained it was felt appropriate to restore a substantial part of the joining awards in light of the candidate’s credentials and work since joining.  We agreed. The executive was not responsible for the circumstances that led to the warnings and is a positive recruit to the company. 

Discussions with other companies covered the level of rewards and the link between performance and reward. 

Voting

Old Mutual Global Investors is has implemented voting across its in-house equity funds consistent with our policy guidelines.  We have also commenced publishing our voting records at the same website. 

Paul Emerton

Head of UK Stewardship and Governance

Old Mutual Global Investors

July 2015