The continuing evolution of corporate finance

Australia's major banks have signalled their intention to stop financing businesses that they, the banks, see as problematic for climate change. These are resources businesses in projects related to fossil fuels such as coal, oil and gas. During proceedings in a Parliamentary Committee hearing last week, the committee heard evidence that such businesses were increasingly turning to private equity and foreign sources of finance.

I think this trend will accelerate. Public companies, particularly the big retail banks in Australia, have seen their shareholder registers evolve over recent decades. The number of shareholders has increased, the average age of shareholders has reduced and the average shareownership value has reduced. Further, Australian superannuation funds have vast numbers of members that are willing to look through the investment portfolios of their fund to see where the investments are actually being made. Shareholders have become more diverse and, inevitably, many have organised themselves into shareholder activist groups. They put pressure on boards via various means to abandon fossil fuel investments.

Most of the directors and senior executives of public companies and the superannuation funds appear to be frightened of shareholder activist groups. It is hard think of any other reason for those entities to denounce fossil fuel projects as a class of investment.  Investment decisions ought to be made on a case by case basis. To impose a ban on financing a certain class of investment is not operating case by case. It is operating according to a bias.  I have no sympathies for corporate leaders who are scared of the prospect of a twitter storm or other noisy attention. The need to appear virtuous has superseded all other investment objectives if whole classes of projects are simply put off limits. That is weak, and possibly in breach of their duties. When you see a corporate entity claiming sustainability virtue points by selling off their coal investments, you see duplicity in action: selling a coal investment to another party is simply taking all future profits now in one net present value lump sum. If those companies genuinely believed the coal project in question should not exist, then it should be shut, dismantled and cleaned up. It should not be sold as a going concern.

Meanwhile, private equity executives do not need to even consider the issue of shareholder activists. They don't exist in the business model. They can make financing decisions based on a project's merits. In some respects, that is closer to how publicly listed banks used to finance business before the revolution in the shareholder base. I anticipate the on-going evolution of financing options. To be sure, the objectives of private equity are different from those of the high street banks but the end result will be the same: worthwhile projects will get their finances arranged. The projects will continue. While the public banks will withdraw, other financiers will step in. The activists will eventually realise that the game moved on while they thought they were winning.

					

Fair trade coffee, quality certification and responsible investing

At the centre of each of these topics lies social activism that always progresses to economic rent-seeking. They start when certain people have a view that a market is failing in some way. Those people make their own judgement and decide that they want to change the particular market. They want to impose their views on the market participants. For example, in fair trade coffee, the central aim is to improve the working conditions and reward to local farmers and labourers in coffee growing areas. In quality certification, the certifying authority believes it is better able to judge quality than the consumer and so its stamp of approval adds an element of protection to the buyer. With responsible investing, the picture is a little confusing at present. Responsible investment agents are not clear on their value proposition – on one hand they present their case as ensuring (their) ethics are brought into the investment decision and so certain investments will be automatically excluded. On the other hand, they try to present this approach as good for investment returns. Well, it can’t be both. More on that later. Continue reading

Allowing access to superannuation assets to purchase first home

Another kite being flown? The Federal Treasurer, Joe Hockey, suggested that the law could be changed to allow first-home buyers access to their ordinarily preserved superannuation savings. Supposedly, this would help them finance the price. The cost of housing in Australia is very high and getting into the market is hard.

If that is a kite, it should be shot down. Such a change in policy would be a very bad decision. The high price of housing is not caused by young people not having access to super money. Nor would the price pressure be eased by allowing such access. In fact, the price pressure would be made worse as extra demand chases an unchanged supply. The prices would rise, the first home buyers would have depleted their super savings and the transfer of assets would have gone to sellers of housing.

Environmental, Social and Governance (ESG) investing – watch out for zealotry

ESG. I’m glad someone came up with another acronym, because I find that in the field of investment, you can never have too many acronyms. This one clumps together the concept of including factors relating to the environment, society and governance into investment decisions. Sounds fair. The problem is that the ESG acronym is a magnet for zealotry.

On 3rd October 2014, the Australian National University announced that it would divest its holdings in 7 mining and resource stocks in its Australian equity portfolio. The reason given was that the University had reviewed its whole portfolio with reference to its Socially Responsible Investment Policy and this group of 7 were to be cut out as a result. Presumably , the blacklisted group did not meet the standards required by the ANU in its policy. This announcement has caused a stir in Australian investment and political circles. The ANU has been criticised, as has its advisor, by commentators, political figures and some of the 7 companies themselves. There is at least one court action underway and there could be further lessons to come out of the process when it is finally over.

In the meantime, if any person investing under a fiduciary duty (eg a superannuation trustee) or as an agent of a principal (eg company executives investing company money) uses ESG principles as a filter to determine the investment universe, in my view they are in breach of their duties. If ESG is elevated to the first criterion and a possible investment is excluded on those grounds alone, regardless of its other prospects, that is a breach of duties. Normally, a decision to invest (or divest) is made after reviewing many factors and ranking alternative investments to get the best possible mix. Factors that we now refer to as ESG factors are almost always included in that assessment, provided they are sufficiently material.  But ESG has the potential to attract zealots who, by virtue of their own personal beliefs, want to exclude certain investments altogether. Specifically, fossil fuels, mining, tobacco and gambling stocks are at risk. ESG advocates want to raise all ESG factors to be the first criterion and only if the company passes those tests does it remain to be assessed against other factors. It is not good enough, according to the ESG advocates, that ESG factors are not given preferential treatment.

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