The Value of Being Actively and Constructively Engaged

by Tim Rankin, CFA, Franklin Templeton Investments

Some activist investors may take to the airwaves in highly public campaigns to force companies to fire their management teams or split up the business. These efforts are sometimes confrontational and may not always be intended to find the best outcome for investors. At Mutual Series, we believe we can usually be more effective working behind the scenes to encourage the changes necessary to create and realise shareholder value.

Constructive engagement has long been a key tenet of our investment process—usually away from the media spotlight—as we look to unlock better performance from our holdings. We have influenced boards to rein in bonus payments in the face of a sharply weaker stock price and have held executives accountable for their failed investments. We are actively involved in the investments we make, believing that frequent and constructive engagement can create significant value over the longer term.

A Catalyst for Change

Engagement is an ongoing process that involves building relationships at all levels of an organisation—from board members and senior management to operating executives and others responsible for leading the organisation. Only by doing so are we able to really understand a company and its culture. Engagement is also a two-way street.

While we expect management to listen and take our observations and suggestions into consideration, we also believe it is incumbent upon us to fully understand their perspective and strategy before offering our ideas. We recognise that not every management decision will go our way, but we believe having an open discussion helps both sides understand each other’s position, and builds trust, which is essential to effective engagement.

As engaged owners and stewards of our investors’ capital, we often talk to management teams about their governance practices and encourage changes when we believe they are falling short. This is fundamental to our investment approach as we believe that good governance starts at the top of an organisation and helps to define its culture.

While strong governance can create the environment to enable long-term value creation for shareholders, weak governance can set a bad tone and be corrosive. In our view, regular, active engagement is crucial in nurturing good corporate practices and reforming bad ones before they cause damage.

More Than Just Talk

An industrial company asked us to take part in a fireside chat for their top executives. They wanted managers to hear our investment thesis, what key metrics we watched, and our assessment of their turnaround efforts. They also wanted our objective appraisal of each of their business units, which included their long-term prospects and how well we thought they were doing in reaching their stated goals.

Finally, they wanted to know how they could improve—both in their operations and in their investor communications. Both parties welcome these types of engagements. It gives company management an opportunity to open their teams’ eyes to investors’ views, and it gives us an opportunity to help shape thinking and suggest changes that we believe will be beneficial.

We have also helped several companies better tell their story to Wall Street. In one instance, a company’s chief executive officer came to visit us. Their stock price had stalled, despite what management perceived to be positive efforts to invest in technology and grow the business. We helped them to grasp that they had failed to get investors to look past the initial short-term costs of these investments and towards their long-term financial benefits.

Following this meeting, not only did the company take more time to explain to Wall Street the cost savings and returns these investments would garner over the longer term, but they also announced plans to return capital to investors to signal that they were committed to being investor-friendly, which we believe helped raise the company’s perceived value, as reflected in the share price.

We also engage with companies that need to change more drastically. In one such instance, we successfully influenced the supervisory board of a European manufacturer involved in a high-profile scandal to ensure management was held accountable for their actions. In the end, the company made several management changes. We have held regular discussions with the same company, among others, in the years since to ensure they are positioning themselves well for the shift away from fossil fuels toward more sustainable energy sources that is currently underway. In this case, we believe the company has become a leader in their markets.

Engagement Supporting Good: The Other ESG

Corporate boards also value our analysts’ industry expertise. Having a shareholder’s perspective in the boardroom matters as many boards only ever hear from company insiders. We are often asked to present our views on how a company’s disclosures stack up against industry peers.

Boards are also interested in the buyback versus dividend trade-off and how their companies rank in terms of ESG (environmental, social and governance) performance, both within their industry and more broadly, and which parts of ESG investors like us really care about.

Furthermore, engagement is a key tenet of our ESG analysis. Rather than ruling companies out of consideration due to ESG factors (negative screening) or choosing best-in-class companies (positive screening), we believe that holistically considering ESG issues should be an integral part of the research process.

We analyse what the company is doing well, and where there’s room for improvement, and try to find opportunities among companies where performance is starting to trend more positively or is misunderstood. We believe that similar to improving operational performance, better ESG performance can boost a company’s stock price.

Shareholder engagement takes courage of conviction and measured risk-taking. Active engagement requires time and patience, but, when effective, we believe the rewards can be significant. As stewards of our clients’ capital, Mutual Series has been an actively engaged owner for decades. Executives and board members welcome our understanding of their business and our long-term perspective, and we believe we can help companies find the right catalyst to generate long-term value. We are actively engaged, not actively adversarial, value investors.

What Are the Risks?

All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stocks historically have outperformed other asset classes over the long term but tend to fluctuate more dramatically over the short term. Investments in fast-growing industries like the technology and health care sectors (which have historically been volatile) could result in increased price fluctuation, especially over the short term, due to the rapid pace of product change and development and changes in government regulation of companies emphasizing scientific or technological advancement or regulatory approval for new drugs and medical instruments. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments; investments in emerging markets involve heightened risks related to the same factors. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. Value securities may not increase in price as anticipated or may decline further in value.

Impact investing and/or Environmental, Social and Governance (ESG) managers may take into consideration factors beyond traditional financial information to select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. Further, ESG strategies may rely on certain values-based criteria to eliminate exposures found in similar strategies or broad market benchmarks, which could also result in relative investment performance deviating.

Actively managed strategies could experience losses if the investment manager’s judgment about markets, interest rates or the attractiveness, relative values, liquidity or potential appreciation of particular investments made for a portfolio, proves to be incorrect. There can be no guarantee that an investment manager’s investment techniques or decisions will produce the desired results.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

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