A growing number of investment managers claim to integrate environmental, social, and governance considerations into their investment strategy and processes, write Tony Davis and Beau Lescott in this Spring issue article, but few have described how they do so in depth. Even fewer reinforce the importance of sustainability within their own firms by becoming a certified “B Corporation.” This article offers a rare, inside look at how one such value-oriented manager uses ESG as a tool for differentiated investment sourcing, underwriting, and corporate engagement with the aim of achieving superior risk-adjusted returns.
One of the main arguments of the article—and a key principle of the firm’s investment approach—is that ESG, as applied to both corporate strategy and operations, is an important factor in determining a company’s cost of capital. The authors present specific examples of their investment process at work, highlighting how active engagement with management on ESG issues can catalyze progress that becomes valued by the capital markets.
Authored by Tony Davis and Beau Lescott
A growing number of private equity firms have responded to the increased focus on climate change, social issues, and technology disruption, write the authors in this Spring issue article, by broadening their corporate mission to encompass all important stakeholders, as well as their limited partners. And in the process, the management of ESG risks and pursuit of ESG opportunities have become increasingly fundamental to the staying power and value creation potential of PE firms by reducing the risk of their investments, discovering new sources of growth, and increasing their resilience to changes in the political and regulatory environment.
This article tells the story of how the Nordic PE firm, Summa Equity, has turned its ESG approach into a core competence and a source of competitive advantage that has enabled the firm to distinguish itself from its competitors and bring about significant improvements in the financial performance of its portfolio companies while providing benefits for their stakeholders. Using the U.N. Sustainable Development Goals to guide them, the firm invests in companies they perceive to be addressing major environmental or social challenges in an innovative and commercially successful way. This has led to investments in significant growth opportunities in areas such as health care, education, waste management, and acquaculture. And the firm’s returns to its investors have been high enough—and the perceived social benefits large enough—that the firm recently closed its second fund (which was significantly oversubscribed) for 650 million euros, and received the ESG award at the 2019 Private Equity Awards in London.
Authored by Reynir Indahl and Hannah Gunvor Jacobsen
In the final article of our Winter issue, the authors explain the role of buybacks in increasing corporate productivity.
In response to a recent New York Times op-ed by Senators Schumer and Sanders deploring the effects of stock buybacks on workers and the economy, the authors explain the role of buybacks in increasing corporate productivity and in recycling “excess capital” from mature companies with limited growth and employment opportunities to the next generation of Apples and Amazons. Some companies, as Schumer and Sanders charge, are guilty of repurchasing shares in the name of “shareholder value maximization” instead of pursuing job-creating investments. But as the authors argue, well-run companies increase shareholder value not by boosting EPS through buybacks, but mainly by earning competitive returns on capital and investing in their long-run “earnings power.” And by paying out capital they have no productive uses for, such companies give their own shareholders the opportunity to reinvest in other companies with promising prospects for growth and jobs.
But the authors go on to note the tendency of companies to buy back shares not when their stock prices are low, but instead when the companies are flush with cash and nearer the top than the bottom of the business cycle. The result of this tendency, as research by Fortuna Advisors (the authors’ firm) shows, is that fully three quarters of companies doing large buybacks during the period 2013-2017 failed to produce an adequate “Buyback ROI,” a metric developed by Fortuna that indicates management’s effectiveness in “timing” its stock repurchases.
Given the usefulness of buybacks in recycling capital, the authors conclude that the most reliable solution to the corporate short termism and underinvestment problem is for companies to adopt better financial performance measures—including Buyback ROI—to guide their capital allocation. And when management determines that it has significantly more capital than value-adding investments, but wants to avoid committing to unsustainable dividend increases, it should consider buybacks—but only if management is convinced that its stock price has not outpaced performance.
Authored by Greg Milano and Michael Chew
The third article of our Spring issue, is a summary of the findings of an event study of the capital market reactions to an inaugural set of 17 CEO presentations of their “long-term plans” to institutional investors. The findings show that, although sell-side analysts appear unresponsive to such plans, both trading volumes and stock prices exhibit significant abnormal reactions to the presentations, providing suggestive evidence that the communication of such plans conveys “value-relevant” information to investors with longer time horizons. Although based on an admittedly small sample, these findings shed light on the promise of long-term plans and have been corroborated by analysis of the market response to the presentations of 10 more companies since the study was conducted.
The authors also provide the outlines of a “content framework” designed to help companies put together effective corporate plans and other long-term disclosures. The framework is organized around nine main “themes,” including policies governing capital allocation, corporate governance, and human capital development, as well as the statement of corporate purpose. After applying this framework to the 17 CEO presentations, the authors find that the more specific and forward-looking the information disclosed in these long-term plans, the more positive the capital market reaction.
Authored by Sakis Kotsantonis, Christina Rehnberg, George Serafeim, Brian Tomlinson, and Bronagh Ward