Who would invest in a sector that has lagged the Stoxx 600 by 1.1% in overall growth and by 0.3% in EPS growth for the last 19 years on an annual basis?
We’re talking, of course, about the financial sector and sadly the answer is most institutional investors.
Encouragingly, some firms have found ways to overcome sector-wide learning disabilities. One is Comgest, which has, by and large, not invested in large mainstream banks since it was founded in 1985.
Why? When I spoke with a senior executive, several reasons stood out:
• It has a “real world” definition of risk – the ability of a company to deliver projected EPS growth for five years.
• It seeks clients who give unconstrained mandates and are aligned with its approach.
• It likes “boring companies” with predictable and transparent business models.
• It has highly concentrated portfolios.
• It adopts a deeply fundamental approach with frequent company meetings.
Comgest’s results speak for themselves: outperformance against the benchmark across most funds for most years with a volatility 20-35% lower than the benchmark over 20-25 years.
So what can be done to make this behaviour less rare?
To be clear, I’ve no commercial relationship with Comgest and I’m still – on balance – an advocate of index investing with really muscular stewardship. But if you invest actively, then much can be learnt from Comgest and similar firms.
The company is still fully employee-owned with fund managers controlling about 70%.
Team function is very important with a very low staff turnover. All research is shared, all portfolio managers are analysts and vice-versa with younger staff actively encouraged to challenge peers.
The fragility of the financial sector is again on the agenda for regulators and experts and whether investors repeat their errors depends on having organisational designs that enable learning.
And arguably even more importantly, investors are now sleepwalking into yet another crisis. This is a view shared by the former CEO of Goldman Sachs and former US Treasury Secretary, Hank Paulson. To wake up especially his Republican peers, Paulson draws some powerful analogies between the financial crisis and the coming climate crisis.
Investors – prompted in part by a vigorous divestment campaign – have indeed begun to respond. Allocations to green bonds are up. But the amounts allocated are still small – considerably smaller than even their allocations to ‘exotic’ alternatives. Some will assert that alternatives deliver value for money. That there’s little evidence for this, across the board, seems to be only mildly inconvenient.
Perhaps even more worrying is growing risk of stranded assets in the fossil fuel sector. In the upcoming edition of the Journal of the Rotman International Centre for Pensions Management, Howard Covington, former CEO of New Star, and I argue that with politicians captured by vested corporate interests, the world seems set to respond to climate change with a “delay and (belatedly) panic” approach. If we’re right, the key question is will you be one of the (many?) investors who sleepwalk into the resulting market turmoil? Or will you be one of those who overcome the sector’s learning disabilities in time?
Interestingly, Comgest doesn’t need to have a particular view of stranded assets because it has also long avoided hard cyclicals for the same reasons as banks. Now that’s active investing. With the world’s major oil and gas companies taking on debt and selling assets on an unprecedented scale to cover a shortfall in cash, the long-term viability of large parts of the industry do indeed look questionable. But do investors with market cap benchmarks care?