“Corporate chief executives complain that the City hasn’t got a clue about what’s going on in the companies in which it is investing because it is a mass of agents,” says Anthony Esse, managing director at UK-based consultancy Darwin Group.
He adds: “Investors are more interested in playing off against each other on a quarter-by-quarter basis as opposed creating long-term growth for their clients, where underperformance in a single quarter would be relatively insignificant.”
Esse and two fellow entrepreneurs established the Darwin Group last year to fill what they perceived to be an information gap in the investment process. Neither pension funds nor city analysts ask the right questions of companies’ management, in his view.
Esse, formerly of Hermes, says that “the focus of the investor community thus far has been on the financial rather than the strategic health of the business. If you don’t ask management the right questions you’re not going to add value in the longer term.”
He adds: “If investment managers do ask the right questions then they will be able to assess more accurately whether they should be committing cash to this business. In this way we won’t see the destruction of shareholder value.”
“Investment managers should be ensuring that the companies in which they are investing their clients’ money are managed by the executive management in their clients’ long-term best interests,” he continues. “Some companies are being financially engineered to meet short term targets; the CEO can massage figures to meet earnings forecasts.”
He believes that the problem is that brokers are remunerated through doing deals as opposed to creating wealth for the people whose assets they are managing. “Something is fundamentally wrong,” he says.
If you aim to retire in 30 years and are going to live to 100 it is clear that a significant amount of money will be required. “Now is that going to be generated by investors playing hokey cokey?” asks Esse. “You want your pension pot to be as big as possible; you don’t want it to be big now and shrink subsequently because someone is screwing up. Our business is about ensuring that investment managers avoid these disasters.”
“People pull out of an investment after having made 20% in a short space of time and think that they have done well,” he continues. “But have they? You can do really well over a relatively short period of time but it is more difficult to perform well over a 20 year period.”
“Nobody has ever washed a rented car,” he continues. “Too many of our assets are used in this way: you use and throw away. If you own an asset you’re going to look after it. The value of businesses is not in the one year time horizon; it might be in the five to seven year time horizon, even though it might be a rocky ride in between,” he says.
“If a company has a larger percentage of smaller longer term owners the share price will be less volatile which will have a positive effect on the weighted average cost of capital, so the co-owners will be better off,” notes Esse. “Investing and owning creates more wealth. So if you don’t want to think about a company for 10 years, don’t think about it for 10 minutes.”
Esse stresses the need for an alignment, rather than a disconnection, of interests. “Management needs to see that investors are for the longer term and that they understand about the business that we are managing on behalf of the owners, among them the pension funds. We need to work together to create longer-term share value by building trust and integrity. From what I have witnessed there isn’t much of it around, and who is losing? The pension funds.”
Esse argues that the problem with discounted cash flow modelling is that it makes guesses about what will happen in the future when what one really needs is a greater understanding the strategic health of the company in order to be able to decide whether a given strategy is sustainable or unsustainable.
Esse argues that combining the skills of a financial analyst and a strategic consultant like McKinsey is a much more powerful proposition than a financial analyst on its own. “Analysts are not likely to rubbish a company if they have a massive M&A going on behind the scenes,” he says.
Darwin is working with investment management houses. “We are also talking to all the internally managed pension funds, pension fund advisers and independent financial advisers,” says Esse.
Despite his criticism of present investor behaviour, Esse views the future with some optimism: “It is reassuring that some investment managers have woken up and understand that what the industry has been doing has been sub-optimal.”
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