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Aug 01, 2010

Bank capital adequacy rules cause headache for investors

Discrepancies in promptness and quality of reporting in Europe persist, says Andrew Lynch, fund manager, Schroders Investment Management

Do you find IROs are generally up to the job?
In the majority of cases, yes. As with any group of people, whether it’s international footballers or investor relations officers, there is a range from the very good to the less good. As a rule, however, investor relations officers are up to the job. 

They are generally well informed about their companies and, if they don’t know the answer to the question, they’re usually happy to put you in touch with the right person in the organization. I don’t think anyone would expect investor relations officers to know the answer to absolutely every question about their company – that would be completely unrealistic. 

Is there an IRO who stands out for you?
The one who stands out for me over the last year or so would probably be Emmett Harrison of Swedish Match. He has been very helpful in helping us understand the impact of [tobacco] tax rises, how the firm is able to pass those through to consumers and the overall impact on the profitability of the business.

Are IROs doing anything that concerns you?
One broad problem area over the last year has been the changes in bank capital adequacy rules. That’s been an area where investors, and probably the banks themselves, have been fumbling in the dark. There has been a lack of clarity, but I think that’s more a problem with the stuff coming out of the regulations rather than any unwillingness on the part of IROs to be helpful. 

Banks are definitely trying to improve their transparency in response to demands from investors and also from external stakeholders. The fundamental problem is that a lot of what banks do – how they allocate capital and how the regulators calculate capital ratios for them – is extraordinarily complicated and not very transparent. 

Without getting right into looking at the internal management accounts – which would obviously pose problems from a securities market and insider trading point of view – you can’t fully understand what most complicated, wholesale banks are up to from the outside. So you have to take certain things on trust, which is part of the risk involved in investing in financials: you will never get full transparency on everything on their balance sheets.  

How do European countries differ in their approach to IR?
There is clearly a gradation in companies’ approach to investor relations across Europe. If one starts in the Scandinavian markets, their reports come out very quickly, you get a full set of quarterly reports and accounts, cash flow, balance sheet and P&L. 

As you move further south, the reports take longer to produce and the amount of published information, particularly for smaller companies, can diminish. When you sit down with a company, it becomes clear it has all of the information; it’s often in the management presentation it brings round on the roadshow. It’s just that it hasn’t put it out in the official quarterly announcements. 

That is something we have said to corporates: more of you should put out your cash flow as well as a statement of net income. But that is a cultural variation across Europe and, if we all became completely homogenized and had just one set of reporting standards, it wouldn’t be as interesting a place.

Do you use IR websites?
I use company websites a huge amount. A well-designed website is a real source of strength for a company when it comes to competition for investment. 

In terms of technology and webcasting, the two that stand out are Red Eléctrica and Energas: where their quarterly calls are webcast, they offer simultaneous translation into English, which is fantastic for those of use who are probably not as polyglot as we should be in the modern world. They also do a good job of making [the webcasts] accessible to the domestic audience and the international audience on equal terms.

How much of annual reports do you read?
We certainly try to go through the financial report, accounts and notes to the balance sheet with a reasonably fine-toothed comb. We also have a read through the management discussion before the actual financial reporting in order to get a proper feel for what’s going on. The discipline of the annual report is that it is a very clear place where management needs to stop, take stock and present that story to investors.   

In the annual report, do you like seeing videos of senior management?
It can sometimes become too much of a presentation. The facts the auditors want the company to present can be more informative than the facts the company wants to present. Video management presentations are useful, but it’s incumbent on investors to get behind that information to see what’s really happening in the underlying business.

Has SOX helped or hindered the reporting process?
Sarbanes-Oxley has been a challenge for many companies. It has produced a lot of extra reporting requirements and so on, but I think it has helped to improve the quality of annual reports by forcing management to say, ‘Okay, given we have to certify these reports and take responsibility for them, we actually need to take a lot of time to draft them properly’. I think that is one of the positive things to come out of the SOX reforms. 

Can you think of a way in which companies can improve their reporting?
One thing that companies should avoid as far as possible is having what we call ‘recurrent exceptionals’ in their accounts. When an event is genuinely exceptional – say, an unexpected hurricane, something like that – there are good reasons for taking exceptional charges. The same goes for restructuring in the economic environment we’ve seen over the last couple of years.  

What we don’t like are companies taking exceptional charges for continuous personnel restructuring year after year. We think that’s a normal operational cost, a normal part of the business – so those expenses should be reported above the EBIT line. 

Do you read CSR reports?
CSR reports are useful. I personally don’t have a specific CSR or SRI mandate, though there are some at other teams in Schroders. But they are important to non-SRI investors because they give you a feel for what the long-term sustainability of the company is. 

No company can survive in the long run if it goes about conducting its business in a way that destroys its legitimacy to operate. It is an important part of what we look at, but we have no black-and-white rule; I’m quite happy to invest in defense companies and tobacco companies, which might be ruled out by other, socially responsible investors. But when you meet a tobacco company, you need to make sure it is farming its tobacco (or buying its tobacco) in such a way that ensures its business is going to survive for another 10, 20 or 30 years.

Fund snapshot: Schroder ISF Euro Dynamic Growth Fund
Assets under management: €180 mn ($235 mn)
Turnover: around 35 percent
Smallest position: Pescanova
Largest position: Total
Top five holdings (active risk): Allianz; BNP Paribas; sanofi-aventis; Société Générale; Ryanair
Source: Schroders Investment Management

Watch Schroders' Andrew Lynch on IR TV
Part one: Are IR officers up to the job?
Part two: How IR practices differ across Europe

Part three: What investors want from corporate reporting 
Part four: Investor relations and technology