Mitigating Risk in the Wake of a Steinhoff
Concern over how to mitigate stock market risk has come increasingly to the fore in the wake of the Steinhoff scandal. Yet, no matter how diligent fund managers may be, it remains extremely difficult for them to spot potentially bad investments, simply because they are on the outside looking in.
Malcolm Fair, MD of investment firm RisCura, says a series of interviews conducted with fund managers found that most had battled to anticipate Steinhoff and other scandals like African Bank through traditional analysis.
“Something we picked up in the interviews was that going through a typical checklist of financial metrics, audit reports, pending legal issues and news reports doesn’t necessarily flag these types of bad investments,” he explains. “When seen together, the presence of a dominant and very charismatic leader in the organisation, coupled with an acquisitive business model (the buying of a lot of companies), and financial statements which have significant intangible assets or require restatement because the existing year isn’t comparable with the prior year, seem to indicate that there may be a problem.”
According to Fair, in the wake of the Steinhoff discussion, some fund managers have now found other listed shares which fit a similar profile and are therefore of concern. “We’ve seen discounts appearing in those shares,” he observes.
Assessing other factors
Fair says the fund managers who are more likely to foresee a problem like Steinhoff or African Bank are those who assess broader environmental, social and governance factors – including issues such as quality of corporate governance in the organisation, the state of labour relations, the impact on the environment and the company’s attention to human rights issues.
“Research shows that where controversies are manifesting, those companies tend to have more risk – and the downside risk to the share price is often greater than the upside risk. So
there’s no excuse for fund managers not to be thinking through these things in their portfolio construction. There’s also no excuse for them not to know about brewing controversies in companies, as nowadays there’s a range of tools out there that can help uncover them.”
He says that fund managers who apply a high level of analysis to such risk factors tend to avoid the big losses and tend to have better portfolio construction processes.
Reducing the risk
Kurt Benn of Absa Asset Management notes that while it is difficult for a fund manager to detect a Steinhoff or Enron-type fraud, there is a constant search for ways to reduce the risk of it occurring. Absa has a very strong focus on interacting with companies to ensure responsible investing is taking place and is embedded in their core philosophies, he says.
However, he adds that when situations like Steinhoff do arise, they force the market to put even more focus on responsible investing, which is ultimately a good thing.
Stiff penalties
Azad Zangana of Schroders believes one way of reducing fraud risk is by ensuring there are stiff penalties for anyone involved. “But you also need to have good regulatory practices, such as the rotation of audits, so that it becomes more difficult to hide this type of fraud. That’s a role for the regulator,” he says.
However, he warns that the rise of passive investing may mean more, rather than less risk of global frauds occurring. “The whole point of passive investing is not to even look at the companies you’re buying – you’re just buying the market. So it’s very dangerous, because there’s no scrutiny at all. This is where active fund managers will be rewarded more, because they take time over their investment decisions and avoid some of these issues.”
60 An Absa Investment publication
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