W&F Issue 5 2018

www.wealthandfinance-news.com 8 Wealth & Finance International - Issue 5 2018 Companies must demonstrate strong, deep relationships and the transparency to reduce the risk of corruption and malfeasance. This is a much more nuanced approach than a “check the box” exercise done by some research organisations. It is important to determine the actual behaviour of the country or company versus its stated intent. Most analyses focus on the stated intent that is akin to the visible part of an iceberg. However, the important information, the actual behaviour, is like the submerged portion of an iceberg. The key to success is researching and incorporating this hard to find information. Therefore, an iceberg is an excellent metaphor for traditional analyses regarding countries and companies. Most active and passive approaches to international portfolio construction ignore the fact that every country has unique legal, regulatory, and economic infrastructures. The resulting differences in individual country economies have implications for equity valuations. If company-level measurements impact financial projections and those projections are very important to investment decisions, then country-level measurements should equally impact investment decisions. When considering international equity investments, investors should seek to determine the following: • Do financial statements accurately reflect a company’s position? • Are shareholders protected and is there appropriate and effective regulation? • Can company leadership make decisions confidently and without interference from a corrupt government? The significance of these questions can be validated with examples from around the world. Much traditional investment analysis is grounded in spreadsheets forecasting future profits of a company. The projections imbedded in these spreadsheets are usually mere extrapolations from recent financial statements. Thus, since the financial statements of companies in China are not always reliable or accurate, the resulting projections of these companies’ future values can be highly inaccurate. Using unreliable and/ or inaccurate financial statements to create forecasts of future financial performance, is counterproductive and is likely to lead to suboptimal investment decisions. Country specific risk considerations are also key to establishing the value that can be found in a specific investment. Companies create value by deploying capital on opportunities. The ability of a company to convert the opportunity into value is impacted by a spectrum of risks. When a country provides a healthy environment, companies face less country risk. Low country risk means more projects to create value are attractive and projects are more likely to produce the desired result. Simply put, more value can be created when risk is minimised by a healthy environment. Thus, country-specific considerations have a material impact on the value of a company. Increasingly investment professionals are beginning to realise the importance of countries. In 2015, Gabriel Research & Management conducted an important survey on the role of country governance in investing. In the survey, 89% of respondents agreed that effective governance is a critical driver of investment performance. However, the increased awareness of the importance of countries is not usually part of portfolio construction as traditional investment analysis does not include country considerations. To support investors in making informed decisions, Magni has replicable research and investment processes for turning key insights about governance into investment information and indexes, simply by scoring all investible countries in the world based on their demonstrated record of good governance. The firm recognises that when it comes to investment decisions, Countries Matter™. Magni’s research database is based on the Sustainable Wealth Creation principles and contains data on 280 Qualitative Sovereign Factors grouped into 12 Economic Standards. Research on the Qualitative Sovereign Factors is accumulated to determine a score for each Economic Standard and then combined into an overall Magni Country Score. The higher the country score, the greater the adherence to the Sustainable Wealth Creation principles, the greater the weighting in the index. Fundamentally, good corporate governance is based on the same foundation as good country governance: honesty and transparency as assessed through corporate behaviour. Country governance is granular as it assesses the infrastructure of a country, while company governance is detailed in that it assesses the stakeholder relationships. The two analyses are closely related. Magni’s Corporate Governance Assessment takes the research methods used on good country-level governance and applies them to a best practices model for corporate governance, thus creating the Sustainable Value Creation principles. These principles analyse 316 qualitative factors for each company. Magni not only assesses each company’s relationship with its shareholders and employees, but also with its customers, suppliers, competitors and the community in which it operates. This approach provides a complete and holistic analysis of Researching G overnance for a Better Investment governance that incorporates the social aspects of ESG investing. The secular model used by Magni has also been integrated with religious guidance to create the Catholic Values and Islamic Stewardship models for corporate governance. Most traditional models for faith-based investing just use negative screening. In these traditional models, companies are excluded from a portfolio based on a list of prohibited products or activities. Such negative screening is important, yet religions have guidance on behaviour regarding that which is desired and considered good. The religious models from Magni differ from most traditional religious portfolios by including the guidance regarding good behaviour. The Catholic Values model integrates Catholic guidance for business from chapters 7 and 8 of Catholic Social Teachings. The Islamic Stewardship model integrates Islamic guidance for business from the Maqasid . The Maqasid are the overarching objectives of Shariah. While the three corporate governance models have many areas of overlap, each is different as the Catholic Values and the Islamic Stewardship have topics uniquely relevant to the specific religion. Magni has created six governance indexes, three international indexes on countries and three corporate indexes using the companies in the US S&P 500. Across each of the governance assessments, Magni generates scores for countries and companies. The scores are used to determine allocations in each index, which are available on Bloomberg, Thomson Reuters, and Magni’s own website. Academic studies are confirming what Magni already knows: governance is important investment information and a focus on governance has been shown to be a driver of performance. With 17 years of data, Magni can show the importance. Governance is much more than a “check the box” activity. Governance is about honesty and transparency. Honesty and transparency need to be assessed by observing behaviour. As with an iceberg, this essential information is not easily seen but should be used to make good investment decisions.