INVESTMENT PROCESS
collective insight
By Asief Mohamed & Tinyiko MabundaAvoid getting caught up in investment
A more sceptical approach to investing needs to be adopted to avoid or reduce the loss of capital for investors.
w
ith an increasing rise in
the cost of living and a
contracting economy, there
is a lot of pressure to deliver
above-average returns for investors. The hunt
for lucrative investments is a fierce one and
investors will often overlook the qualitative red
flags associated with potential investments in
search of the hidden gem.
There is no one successful method to
detecting a financial scam. Investors cannot,
unfortunately, be fully immune and protected
from such scams. Even highly experienced and
educated portfolio managers sometimes fall
prey to companies that, at the time, seemed
undervalued. But then they’re confronted
with the salty blow of a company’s Sens
announcement notifying shareholders to
disregard the reliability and accuracy of their
financial reports.
It is important to avoid the “noise” around
seemingly tempting investments and to
conduct thorough due diligences. In
addition to constructing a financial
valuation with a high margin
of safety, investors should
also place emphasis on
qualitative research such as
environmental, social and
governance (ESG) analysis.
Often, anecdotal
evidence helps one
steer away from scams.
Investment analysis is no
longer just about numbers; a
more holistic approach to research
is needed when determining the quality
and value of an investment – such as
factoring in the notion of “once a thief most
likely always a thief”.‘Too good to be true’ investments
In the search for alpha and overall
outperformance, active investors are always
looking for under-valued investments. Once
invested, it’s easy to justify remaining in an
unsuccessful investment to avoid admitting
one’s error.
However, for a large number of asset
managers, it is especially important to
remember their fiduciary duty to their clients,
to be self-aware that their original investment
case might have been wrong and to promptlyreverse their investment decision in order to
protect their clients' assets.
Companies such as Steinhoff International
and Tongaat Hulett are recent examples of
the devastating financial impact of white-
collar crime. Since Steinhoff’s heed of the
“accounting irregularities” and Tongaat Hulett’s
announcement of their inflated profit, investors
and pensioners have lost a combined market
value of approximately R290bn – possibly as
large as alleged state capture losses.
An investment that is too good to be true is
particularly difficult to scope out if the market
is yelling “BUY!”. It’s crucial for a responsible
investor to justify their investment case and
resist the call of the herd.Transparency in the financial industry
A higher degree of transparency is required
within the financial industry. This industry
is largely driven by money and with it,
unfortunately, greed often follows.
As such, effective control measures
have to be implemented to ensure
that money flowing in and out of
the business is legal, accurate
and justified, and that it’s
received and transferred to
the rightful person(s) and/
or corporations.
An objective,
accountable governance
structure and a fair
remuneration plan are key
foundational blocks to ensuring
transparency within a company.
Corporate governance lapses have
been a recurring topic in South Africa. Even in
the face of an ever-evolving financial market,
theft and fraud at management level remains
a high threat. Shareholders, both institutional
and retail, have to play an active role in holding
management accountable to their actions and
decisions.
One way to ensure this, is for investors to
engage with the board on issues that include
but are not limited to fair remuneration policies,
director independence and the effectiveness of
elected management teams.
Companies often draft remuneration policies
with unsubstantiated executive pay structures.
These policies implement key performance
indicators (KPIs) that aren’t aligned to keybusiness strategies and carry high weightings,
thus enabling CEOs to award themselves with
ridiculous and excessive bonuses.
KPIs must be fairly weighted and relevant.
If, for example, a company’s operations
have an adverse effect on the environment,
non-financial targets – which measure
management’s ability to reduce and rehabilitate
the environment they operate in – need to be
included in determining the awarding of short-
and long-term incentives.
The gender pay gap and the CEO-to-worker
pay ratio – the difference between the CEO’s
remuneration and the median employee
remuneration – also need to be disclosed to
improve transparency.
Board directors guide the quality of
governance within a company. Investors need
to consider the number of external directorships
that board members hold. If a director sits on
more than three boards of listed companies,
one has to question the director’s level of
active commitment to their current role. Are
they allocating adequate time to their duties to
detect misstatement and fraud?
King IV stipulates that a balance of power
must exist within a board. It steers away
from a tick-box approach when assessing
independence. Listed companies are not legally
required to implement this approach as it is
merely a guideline. This creates discretion and
room for failure to timeously identify current
and potential conflict of interests when electing
non-executive directors.
Therefore, it’s imperative that companies
disclose their independence assessment criteria
and subsequent director independence scoring
in their integrated reports and notice to their
annual general meetings. This will provide
shareholders with a better understanding and
assurance of independence.
The impact of a potential scam can be
avoided, to a certain extent, if adequate
investment processes are followed, and
meaningful company engagements are
conducted. Companies also have to play
their part by remaining actively transparent- not only when compelled to do so through
proposed shareholder resolutions. ■
Asief Mohamed, CA (SA) and CFA charter holder, is the founder
and chief investment officer of Aeon Investment Management.
Tinyiko Mabunda is a research analyst at Aeon Investment
Pho Management.
to:^Shutterstock@finweek finweek finweekmagazine finweek^ 15 August 2019^27