Book Review – Investing for Growth

“Investing for Growth” is a recently published book by Terry Smith, the founder of the Fundsmith fund management company. Anyone who has invested in his Fundsmith Equity Fund, as I first did 7 years ago, will find the book to be simply a refresher on the principles Terry Smith first laid down and has stuck to ever since. That can be summarised as “buy good companies, don’t overpay and do nothing” – the latter meaning don’t over-trade.

The book consists of a mixture of the Fundsmith Equity Fund annual reports over the last ten years, plus articles Terry Smith has written for various publications in that period. It tends to be somewhat repetitive and could have done with some more aggressive editing. It does of course highlight the strong performance of the Equity Fund over the last few years which has attracted many private investors so that it is now one of the largest UK funds. You can see the details of the fund’s performance here: https://www.fundsmith.co.uk/fund-factsheet which shows an annualised return since inception of 18.2% per annum, well ahead of its benchmark.

The book is a good reminder of how Terry Smith has achieved this success which is worth any investor understanding. But there are a few articles in the book worthy of particular mention that even investors in his funds may not previously have been familiar with, which I shall pick out.

The chapter entitled “Lessons of the Great Wall Street Crash” makes some interesting comments on the causes of that crash and what he suggests was the failure to deal with it properly – even by FD Roosevelt who normally gets a lot of credit for the eventual revival. It complements well the previous book I read called “Boom and Bust” which also covers that subject.

Another chapter is entitled “Why buy Brics when you can have Mugs?”. This covers the question of whether you should invest in developed market economies (typically North America and Western Europe) when clearly there is rapid growth taking place in some economies, typically called “Emerging Markets”. Terry wrote the article in 2014 when investing in Brazil, Russia, India and China were the popular countries to back. He reported that investing in an emerging market index tracking fund over the previous 5 years would still have underperformed a developed market index.

I recall looking at this issue when I first started investing 20 years ago. Should one back countries where you may know little about them other than their economies are forecast to grow rapidly? As of course China and India have subsequently achieved. But the answer in reality is far from simple. Looking at the latest statistics covering the last five years for a few investment trusts, the only certainty seems to be that investing in the UK “All companies” sector would have been a very poor choice as against a Global fund, or even a North American fund. In fact as US stock markets dominate the overall world value at about 50% of market valuations, that distorts any Global fund figure. With the UK being in a political crisis over Brexit that clearly damaged overseas investors view of UK shares, plus of course the FTSE-100 is full of “mature” companies in sectors with little growth, while the USA has many leading technology companies. As Terry Smith says “If you are willing to invest on the basis of a snappy acronym with no regard for the political and economic characteristics of the countries, perhaps you should have subscribed to the MUGS – Moldova, Uganda, Greece and Suriname. The key is surely to back fund managers who have a proven record in their chosen sectors such as Mr Smith.

Another interesting chapter in the book is headed “Why bother cooking the books if no one reads them?”. Terry Smith first made his name by publishing a book entitled “Accounting for Growth” which showed how the accounts published by companies were frequently manipulated to fool investors, particularly as regards acquisitions. Since then accounting rules have been tightened up but companies, and analysts, have now chosen to promote “adjusted” figures. He highlights restructuring charges, exceptional costs (particularly legal charges) and intangible asset amortisation and impairment charges as being used to distort accounts. He particularly attacks pharmaceutical companies such as AstraZeneca and GlaxoSmithKline and I definitely agree with him this has become a major issue for investors.

Other good chapters are “ESG? SRI? Is your green portfolio really green?” and “The myths of fund management”. He clearly enjoys sacrificing the sacred cows of the fund management industry.

I would recommend this book to any investor. It’s an easy read and not too long at 290 pages.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Seminar on Woodford Legal Case

Yesterday evening I attended a webinar hosted by ShareSoc on a proposed legal action over the substantial losses suffered by investors in the Woodford Equity Income Fund (WEIF). It was chaired by Mark Northway and Cliff Weight with other speakers being Boz Michaelowska from legal firm Leigh Day and David Ricketts. The latter is a financial journalist who has written a book entitled “When the Fund Stops” which covers the past events at the Woodford funds and which will be published in the New Year. It is already available to pre-order.

Leigh Day have identified a case against Link Fund Solutions, the Authorised Corporate Director (ACD) for the fund and which is part of a large financial group (Link).  Leigh Day’s investigations lead it to believe that Link allowed WEIF to hold excessive levels of illiquid or difficult-to-sell investments, and that this caused investors significant loss. In doing so, they consider Link breached the rules of the FCA Handbook and failed to properly carry out the management function of the Woodford Equity Income Fund.

This writer never personally held any of the Woodford funds, but having been involved in two previous large legal actions (over Northern Rock and the Royal Bank of Scotland), it was interesting to hear about this one. ShareSoc is endorsing and supporting the Leigh Day case and is providing a discussion forum for investors – see https://www.sharesoc.org/campaigns/woodford-campaign/ . They are taking up other issues not covered by the legal claim such as the failure of regulation to prevent the collapse of WEIF.

Some 600,000 investors were affected by the closure and wind-up of WEIF and have lost very substantial sums of money – over 25% of what they invested based on some calculations over a few years, in a period when the stock market was otherwise booming. As much as £1 billion in losses were suffered. The decline and eventual closure of WEIF was driven by investment in small cap, often unlisted, companies which proved very difficult to sell and could be considered unwise investments to begin with.

Leigh Day seem to be putting together a sound legal structure required for such an action – a Group Litigation Order, with after the event insurance to protect claimants with a “no win, no fee” financial structure and support from litigation funders. The latter and the associated costs mean that claimants, even if the case is won, will only receive about 70% of the proceeds, even assuming Link can pay which is not clear.

However, investors in WEIF have little to lose from supporting this legal claim although Leigh Day have not yet disclosed the details of their claim.

Note that they are not at present pursuing Neil Woodford, nor his fund management company, nor Hargreaves Lansdown who actively promoted the Woodford funds. Nor are they pursuing a case over investment in the Woodford Patient Capital Trust now taken over by Schroder (NAV down 73% in the last 5 years).

But there are several other legal firms mounting cases over the Woodford funds who might be covering other claims. As I experienced in the past legal cases in which I was involved, lawyers are keen to get involved as they see potential fees of several millions of pounds in the pipeline from pursuing such cases.

Note that investors might also consider a complaint to the Financial Ombudsman which might be an alternative route to redress.

Comment: The ShareSoc seminar provided a very clear exposition of the legal case and past events. It is good to see that ShareSoc is not backing off from involvement in legal claims where they have examined the case carefully and have some assurance that it is being well managed.

My view is that investors in WEIF should support the Leigh Day claim and should register their interest, but they need to be aware that such legal actions are always uncertain and can take many years to come to a conclusion. But if the case focusses on the role of Authorised Corporate Directors (ACDs) that might ensure that they take more care in future to monitor the activities of individual fund managers.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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The Advantages of Investment Trusts

The AIC has issued a video which spells out some of the advantages of investment trusts over open-ended funds. They spell out that with most investment products you don’t have a say, but with investment trusts you do because you can vote on important decisions about how your company is run and what it invests in. You can also attend the Annual General Meeting (AGM) to meet, and question, the board directors and the investment manager. Investment companies also have independent boards of directors.

You may think that all of this is theoretical and in practice shareholders have little influence. But that is not the case. When push comes to shove, shareholders can change the fund manager and even the board of directors. I have been involved in several campaigns where this actually happened – not just in smaller companies such as in VCTs but at Alliance Trust. The outcome is usually positive even if a revolution does not actually take place.

But attending AGMs is now only available as an on-line seminar using various technologies. I have attended several in the last few weeks of that nature, and they are less than perfect in some regards. Technology is not always reliable and follow up questions often impossible. But they do save a lot of time in attending a physical meeting and they are certainly better than nothing. I look forward to when AGM events can return in a “hybrid” form where you can attend in person or via a webinar.

The AIC video is available from here: https://www.theaic.co.uk/aic/news/videos/your-investment-company-having-your-say

Brexit

I see my local M.P. Sir Bob Neill, is one of the troublemakers over the Internal Market Bill. He gave a longish speech opposing it as it stands in the Commons. But I was not convinced by his arguments. Lord Lilley gave a good exposition of why the Bill was necessary on BBC Newsnight – albeit despite constant interruptions and opposing arguments being put by the interviewer (Emily Maitlis). A typical example of BBC bias of late. Bob Neill is sound in some ways but he has consistently opposed departure from the EU and Brexit legislation. To my mind it’s not a question of “breaking international law” as the unwise Brandon Lewis said in Parliament but ensuring the principles agreed by both sides in the Withdrawal Agreement are adhered to. Of late the EU seems to be threatening not to do so simply so they can get a trade agreement and fisheries agreement that matches their objectives.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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FCA Seminar and Property Funds Rule Change

The Financial Conduct Authority (FCA) is consulting on a rule change for open-ended property funds. The problem of such funds holding illiquid investments in direct property are well known. If investors want to sell when property goes out of favour, the funds simply cannot sell their underlying holdings fast enough. It can take months to do so when investors in the funds expect their cash immediately. Or as the FCA puts in, there is a mismatch between the liquidity offered to investors in the funds, and the liquidity of the fund’s holdings.

This problem has resulted in the funds having to be “suspended” or “gated” to stop redemptions, and many still are after the March crash this year.

The FCA’s solution is to require investors to give notice before they can get their cash – potentially up to 180 days. But this would probably mean that investors would not be able to hold such funds in ISAs, unless their rules are changed. Needless to say, investors who currently do so are not going to be best pleased as they would have to sell them.

This is a very simplistic solution to a long-standing problem, and to my mind may not solve the problem as disposing of property can take longer than 180 days if you want to obtain a fair value for it. Permitting illiquid investments of any kind to be held in open-ended funds is simply wrong.

Such funds should be wound up, or converted to investment trusts which is surely not impossible. Meanwhile I won’t personally be responding to this consultation as I am not so daft to hold such funds, only property investment trusts.

See the FCA press release here for details: https://www.fca.org.uk/news/press-releases/fca-consults-new-rules-improve-open-ended-property-fund-structures  and for how to respond to the consultation.

Yesterday the FCA presented at a seminar hosted by ShareSoc and UKSA as a webinar. Mark Seward was the speaker from the FCA but he did not cover the above issue at all (he is responsible for “Enforcement and Market Oversight”).

He did cover the outcome of the Redcentric case where grossly misleading accounts were published. He said the investors had “purchased a lemon”. They did not fine the company, but the company is compensating the shareholders affected and 3 former executives are awaiting trial. He explained the reasons for the FCA’s actions which seemed reasonable to me (I never held the shares though – those more familiar with the case might have a different view). He also mentioned the Burford case and the legal decision re disclosure of trading data and made some uncalled for derogatory remarks about the comments made on it by some ShareSoc members.

He covered the emergency measures introduced by the FCA for the Covid-19 epidemic which he said enabled the UK markets to raise 3 times more capital than any other European market in the first half of the year. But Mark Northway raised the issue of the problems of private investors participating in these fund raisings. I would also have liked to see the issue raised of companies not providing access to AGMs nor any other means for shareholders to talk to the directors while the epidemic rages.  

Another issue discussed was the outright refusal of the FCA to provide any information on the progress of an investigation. This is exceedingly frustrating for investors as it means after a complaint is made, there is no apparent action for many months if not years. When many of the facts are reasonably well known and in the public domain already (as in the Redcentric case, or in other cases such as those of Globo or Patisserie) this can appear quite unreasonable.

Mark Seward suggested that no regulatory body (for example, the Police) discloses anything about their investigations, partly because the evidence might disappear if they did. But this is simply not true. The Police often inform victims of crimes about the progress of a case, sometimes albeit on a confidential basis. Victims and the police are also entitled to follow the “Code of Practice for Victims of Crime” published by the Government which the police have to adhere to (but not the FCA who are specifically excluded for no good reason).

The seminar was not altogether a waste of time, but could have had a much sharper agenda.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Tech Stocks Bubble Bursting? And Is Stockpicking a Waste of Time?

The bubble in technology stocks seems to be bursting. There were a couple of interesting articles published in Shares Magazine and in the Financial Times this week. The first was headlined “Tech Stock Mania”. It suggested investors had been piling into technology stocks in volumes not seen since the dotcom bubble of 1993/2000 which I well remember. That was an age when the market valuations of such companies became totally detached from reality and the fundamentals on which you value companies. The mantra was that growth was everything to capture market share in the brave new computer software and internet world. Is it different now?

Technology stocks have been attractive of late because revenue growth is still there and the avoidance of personal contact has driven the need for more digitization and for new software products. Shopping has moved decisively to the internet and video tools and social media have become more widely used. Zoom’s share price has risen by 260% since the start of 2020 and electric car maker Tesla almost as much making the company the most valuable car producer in the world, even though they produce relatively few cars. There was a general rise in all the big technology shares this year until a sell-off in mid-July. It appeared that the increase in valuations was being driven by momentum as investors bought in response to share price rises, which is a great merry-go-round if you can jump on and off at the right point. Just looking at the vertiginous charts of some of these companies can spook you. It’s not that I am a great follower of charts, but when I see a rise in the share price faster than any growth in sales or profits, then this tells me that the market is getting over-excited.

I am of course a great believer in the merit of technology companies where growth can be achieved but past technology giants did not always grow for ever – IBM, Hewlett-Packard and Oracle are good examples. Management errors in not keeping up with technology and market changes are usually the cause, i.e. they collapse like empires from their own internal weaknesses.

I have to admit to recently selling a few shares in the large investment trusts that invest in technology companies – you can guess which they are. The private investors and institutions who buy the shares in such trusts may have even less real view of what is happening in the real world and hence their share price discounts have shrunk to zero or are even negative.

The mega-cap technology stocks such as Apple, Microsoft, Amazon, Alphabet and Facebook now represent more than a fifth of the US stock market according to an article in the FT. That is surely a dangerous level of concentration. Investors seem to think that such companies are not just defensive because of their near-monopoly control of certain markets, but that they still have growth opportunities. They may be right but there is a limit to how much you should pay for any business when the valuation is founded on future growth. Sometimes the growth disappears as markets become saturated and the valuation then crashes as valuations are a discounted calculation of future earnings.

The big winners from the technology boom have been stock-pickers. But Chris Dillow wrote an article for Investors Chronicle a week ago that was headlined “The Impossibility of Long-Term Stockpicking”. It argued that because few listed stocks survive for many years on the market, you are wasting your time stock-picking. Also only 1.3% of shares accounted for all the rise in global markets between 1990 and 2018 according to academic research. The three companies that accounted for 6% of it were Apple, Microsoft and Amazon which were never sure bets if you look at their history.

Mr Dillow therefore argues that as you have no hope of picking the winners you might as well buy an index tracking fund, and you would have done better to hold cash than invest in small cap stocks on AIM.

The article is well worth reading but I am not convinced. My investment portfolio has done better than the FTSE-Allshare over the last 20 years. It might apply to unsophisticated investors that an index tracker may give a good return with minimal effort but you do have to take into account the management charges. You also need to consider what index to follow – global index tracker of large companies perhaps? If so you will have significant exposure to currency risk and the fact that large companies generally underperform. You still have to make some investment decisions and they won’t be any easier than studying individual companies.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Bank Dividends and Fundsmith Performance

The bad news for many private investors is that most of the major listed UK banks are suspending dividend payments, even ones already announced. This is after they received a letter from the Bank of England requesting that they do so. The dividends are unlikely to be resumed before the end of the year. This is surely a prudent measure as the banks will undoubtedly have many requests for loans from companies to tide them over the virus crisis, while other companies will default on loans already made.  Bank balance sheets are always on a knife edge which is one reason I don’t hold shares in them.

Another investor who does not invest in banks is Terry Smith of Fundsmith. He has just published a letter to investors about the year to date performance of his Fundsmith Equity Fund. It is down only 7.9% when the fund’s benchmark MSCI World Index is down 15.7% and the FTSE-100 is down 23.8%. See www.tinyURL.com/tfjuzno for more information. As I hold the Fundsmith fund, it’s probably made my portfolio performance better than it otherwise would have been as a number of small cap stocks I hold and investment trusts have fallen further. I have not been selling the Fundsmith Equity Fund so that may be one of the few wise decisions made of late.

Terry Smith’s has another go at “value stocks” in his letter. He says they don’t protect you in a market downturn mainly because they are lowly rated for good reason. They are often cyclical, highly leveraged, have poor returns on capital or face other challenges. He could be referring to banks!

Another wise comment he makes is “What will emerge from the current apocalyptic state? How many of us will become sick or worse? When will we be allowed out again? Will we travel as much as we have in the past? Will the extreme measures taken by governments to maintain the economy lead to inflation? I haven’t a clue”. Comment: I don’t either, but like Terry I believe that investing in good businesses remains the best strategy.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Miton UK Smaller Companies Fund In Decline

There was an interesting article published a couple of days ago by Citywire on the problems at the LF Miton UK Smaller Companies Fund. The fund is managed by well known investor Gervais Williams and Martin Turner and focuses mainly on AIM listed companies. Performance in 2019 was dire with the fund losing 14% when the sector was up 25%. Over the last 18 months this open-ended fund has shrunk by 75% as investors bailed out.

In the Citywire article Gervais is quoted as giving some positive comments including “The stocks in the fund are particularly undervalued on a relative and absolute basis, with an overall price-to-book ratio of 1.1 times, for example, versus 2.2 times for the FTSE AIM All-Share index”. A quick look at the portfolio gives me some doubts though.

The top holdings are Aquis Exchange, Kape Technologies, CentralNic Group, Totally, Corero Network Security, Kromek Group, Amino Technologies, Frontier IP, Hydrogen Group and Reabold Resources. I have held CentralNic and Corero in the past but not currently. Corero who operate in the digital security (DDOS) sector has been a consistent disappointment over many years with repeated placings required. Perhaps some of these business are undervalued and may turn into winners in due course, but the problem with holding small caps in an open-ended fund is that a hiccup in the overall fund performance causes investors to sell the fund and that means the fund manager has to sell some of the relatively illiquid shares to meet redemptions. That drives the share prices down.

This is similar to the problem Woodford had but in a slightly different form. The Miton holdings are at least listed but probably quite illiquid, i.e. low normal share volume and selling the size of holding that Miton might have would be difficult. But it’s similar in that the managers seem to have lost their touch at share picking.

The situation works in reverse of course if the fund grows in size after a positive period. Folks pile in and the share prices of the shares the fund invests in are driven up.

One has to question whether this kind of fund should be an open-ended fund rather than an investment trust. The bigger the fund grows (it’s now still £57 million in size), the more dangerous the situation becomes.

But for private investors, one way to avoid this “herding” problem is to invest directly in small cap shares rather than in a fund. Any individual investor may have such a small holding that one can move in and out of the shares without moving the share price too much. Or if you still wish to invest in small cap open-ended funds, make sure you jump on the bandwagon when it’s going up and bail out as soon as there are any performance hiccups.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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FinTech Valuations, EU Harmonisation and Fundsmith Report

I received an interesting item from Sharepad/Sharescope by Jeremy Grime this morning. It was headlined “Culture in Payments” but the interesting part was the coverage of the valuations of Fintech companies. It listed some of the recent takeover transactions of such companies where the valuations ranged from multiples of 1.1 to 7.8 times revenue (Source: W.H.Ireland), but many of them were on more than 7 times. Profits are not even mentioned! One example was UK listed company Earthport, taken over at 7.3 times revenue by Visa when it had been consistently loss making.

The article also mentions three small such UK listed companies – Alpha FX (AFX), Argentex (AGFX) and Equals Group (EQLS) and explains how they seem to be evolving from being primarily suppliers of foreign exchange to evolving into banks. I have an interest in one of those companies and another in the sector, but some of  the valuations seem to be way too high to me. There are clearly a lot of share speculators betting on their future, but not all are likely to be successful. Maybe they are just looking further ahead than me (source of the word “speculator” is Latin “speculatus”, the past participle of the verb speculari, which means “to spy out” or “to examine” but it tends to now mean acting without looking).

Chancellor Sajid Javid has put the cat among the pigeons over the weekend by suggesting on Friday in an FT interview that UK businesses need to prepare for divergence from EU rules. He said “There will not be alignment, we will not be a rule taker, we will not be in the single market and we will not be in the customs union”. This may create potential difficulties for large importers/exporters from/to the EU, such as auto manufacturers, aerospace companies, pharmaceutical companies and food/drink suppliers. It is also somewhat inconsistent with the “political declaration” which was part of the Brexit Withdrawal Agreement.

Perhaps this is just a negotiating position. I hope so because some harmonisation on goods might surely be preferable to ease trade flows, even if we depart to some extent from EU financial regulations and other rules. However, just to give you one example where harmonisation might be objected to, the EU is mandating Intelligent Speed Adaptation (ISA) for all new cars from 2022. Many UK drivers consider this unreasonable as speed limits are often inappropriate and there are a number of technical objections to it. Exporting compliant vehicles to the EU should not be difficult for car manufacturers but for German manufacturers if the UK drops that rule then problems may arise. The devil is in the detail on harmonisation. The answer is surely to agree harmonisation on technical standards where there is an obvious benefit to both parties, but not where the regulations attempt to dictate policies in the UK, or how our citizens behave.

Lastly I covered the latest Fundsmith Equity Fund Annual Report in a previous blog post (see https://roliscon.blog/2020/01/18/another-good-year-for-fundsmith/ ). It’s now available from this web page: https://www.fundsmith.co.uk/docs/default-source/analysis—annual-letters/annual-letter-to-shareholders-2019.pdf? and is well worth reading.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Another Good Year for Fundsmith

Terry Smith has issued his latest report to investors on the performance of the Fundsmith Equity Fund. It contains some of his usual acerbic comments on the financial world which I cover below.

Total Return on the fund last year was 25.6% and that beat the MSCI World Index benchmark which was only up 22.7%. As Fundsmith is one of my bigger holdings, that helped to contribute to my own portfolio performance although my overall gain was better. But that compares with the previous year when Fundsmith was well ahead of my portfolio which has more small cap stocks in it. Undoubtedly investors in Fundsmith will be happy with this continued good performance and the fund has continued to attract new investors so is now the largest UK retail equity fund. Many people have concerns that the fund is now so large that returns may drop away but Terry Smith continues to confound them.

The top five contributors to outperformance were Microsoft, Estee Lauder, Facebook, Paypal and Philip Morris with the detractors being 3M, Colgate Palmolive, Clorox, Brown-Forman and Reckitt Benckiser. Terry continues his management style which he defines as buying good companies, not overpaying and then doing nothing. He also likes to invest in companies with a good Return on Capital Employed (ROCE), good margins and good cash conversion. These are good lessons for all stock market investors.

He derides “value investing”, i.e. buying apparently cheap stocks and the alleged rotation from growth into value. He says “most of the stocks which have valuations which attract value investors have them for good reason – they are not good businesses”. He argues that returns from stock market investment come from the growth in company earnings and the compounding of reinvested retained capital, not from buying cheap companies.

He clearly does not intend to change his investment style and makes some critical comments on the Woodford debacle which he assigns to a change in investment strategy with Woodford moving into illiquid small cap stocks in an open-ended fund.

Fundsmith are holding the Annual Shareholders Meeting on the 25th February for those who wish to question Terry on his management, or on why he is not reducing the fund management charges given the growing size of the fund, although they are not expensive in comparison with some actively managed funds.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Slater Investments Warns on Pay, and Flybe Bail-Out

Slater Investments has issued a warning to companies of their “dissatisfaction with the framework of directors’ remuneration in most public companies”. Slater Investments run a number of funds managed by Mark Slater and others with a focus on growth companies.

The letter complains about a “relentless ratcheting of terms and conditions which have meant the interests of directors and investors have grown steadily further apart”. Specifically it complains about the award of nil-cost options which they see as a one-way bet and they also don’t like the hurdles that are set which are often simply e.p.s. rather than total return.

They also don’t like the quantum of pay awards and say: “It has become customary for executive directors to receive a handsome salary, plus the same again in cash bonus and a similar amount in nil cost options – year in, year out. Is a good salary not enough to get directors out of bed in the morning and to diligently work their allotted hours? A bonus should be determined by the return received by investors”. This is a similar complaint to my own made a week ago.

They plan to vote against remuneration reports which are longer than two pages [Comment: that means most of them at present], and vote against any schemes with nil cost options and against unresponsive members of the remuneration committee. Mark Slater and his firm are to be congratulated on taking a stand on this matter. I hope other fund managers will follow his example.

To read the letter sent to companies, go here: https://tinyurl.com/wu9jh9q

The UK Government is bailing out airline Flybe. It was obviously running out of cash and was saved from administration by the Government deferring passenger duty tax payable, a possible Government loan and more cash from the owners. Is this a good thing?

Flybe operates a number of short-haul flights in the UK and the rest of Europe. Some UK airports are apparently dependent on its operations. Is it really essential to maintain these operations when roads and rail links provide alternative transport options in most cases, albeit somewhat slower perhaps? State aid to failing companies has a very poor record in the UK – the motor industry was a good example of that. One of the few good things about the EU is its tough rules on state aid. I hope that the UK will not diverge from its principles now we are departing from the EU.

Why is bailing out failing companies a bad idea?  For several reasons. First because it effectively subsidizes poor companies which then compete with profitable companies to their disadvantage. Second, it rarely works because a bad business usually remains a bad business. For example, Flybe has been perennially unprofitable and had to be rescued via a takeover in March 2019 when it was delisted. You can see the financial track record of the company on this Wikipedia page: https://en.wikipedia.org/wiki/Flybe

Airlines are one of those businesses that I avoid. They suffer from the business model problem that they are always trying to maximise passenger loading as the economics of airlines means they need to fly the planes full to make money. This means they cut prices to fill volume when business is bad, but their competitors do the same (and their competitors can be other transport modes on short-haul flights such as buses or trains).

It has been suggested that the worlds’ airlines have never overall made money since the airplane was invented. I can quite believe it.

I see no good economic reason why the Government should bail out Flybe in the way proposed. If it owns some profitable routes, other airlines will take them on. There might be merit in reviewing air passenger duty in general which is a tax on travel that does not apply to other transport modes, or perhaps in providing some specific funding to unprofitable routes as suggested in the FT if there are good arguments for doing so and with onerous conditions attached. But the principle should be “no money unless the business is restructured forthwith with some certainty that it can be made profitable”.

Otherwise the danger is “moral hazard” as Lord King mentioned when refusing to bail out Northern Rock, not that I think he was particularly wise in that case. It is suggested that it just encourages the directors of companies to believe they will be rescued regardless of their incompetence. The threat of no more assistance ensures directors take more care it is argued and provides an example to others. Banks may be rescued with cash that the Government prints to shore up their balance sheet, but putting cash into airlines is typically just used to fund operating losses.

Businesses that are subject to Government regulation are always tricky to invest in. If they are not subsidising the competitors, they are restricting competition by regulation. Which one of my US contacts was explaining to me a couple of weeks ago as one reason for the demise of PanAm.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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