Becoming an Expert Investor: Combining Analysis and Intuition
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Transcript Becoming an Expert Investor: Combining Analysis and Intuition
Long Horizon Investing
and
Extra Financial Factors
James O’Loughlin,
JOL Consulting Ltd
Two Questions
• Who put the “bop” in the “bop
sh-bop sh-bop?”
• Who put the “extra” in “extra
financial factors?”
Extra-Financial Factors
• Include but not restricted to
Intellectual capital management
Human rights
Occupational health and safety
Human capital management
Innovation
Research and development (R&D)
Customer satisfaction
Climate change
Corporate governance
Consumer and public health
Reputation risk
Environmental and social impacts of corporate activity
Plan of the Presentation
• The opportunity for long horizon
investing and enhanced analytics
• A new generation of investor
• How fund managers might use extra
financial factors
• Partnership for investing
• The additional prize
• Getting from here to there
The Disconnect
• Sophisticated
analysis
• Short-term and
narrow focus
DCF valuation
Earnings-based
models
Considered
treatment of
intangibles
heuristics
Single period
PE ratio
analysis
Pattern Recognition
The Investor’s Task
• Pattern recognition
See what we expect to see
EPS
Sales
Growth
Pricing
‘Blindness’
f
m
Corporate
Gov’nce
Equity
Value
ROIC
l
k
Cost of
Capital
M&A
h
i
j
Profit
Margins
• Salience
g
Tangibility
Measurability
Trustworthiness
Ambiguity aversion
Truncation
Extra-Financials Defined
Extra-financial factors are those which are
likely to have at least a long-term effect on
business results but which lie outside the
customary span of variables that get integrated
into investment decisions, irrespective of
whether they are part of the research process.
• Not an artifact of the data
• An artifact of our proclivity to pay attention to
salient data and to process it according to
learned models
The Opportunity for Long Horizon
Investing and Enhanced Analytics
• Industry-wide focus on narrow financial
indicators of corporate performance
• Diversity siphoned from investment
decision making
• Alpha left on the table for investors who
know better
• Widespread misallocation of capital
With additional knock-on consequences
Enhanced Analytics for a New
Generation of Investor
• Enhanced Analytics Initiative (EAI)
Over $1 trillion under management
Minimum allocation of 5% of brokerage commission
Incentivises broader and longer-term perspective
• A new Generation of Investor
Novel data in familiar and trusted format
Required knowledge
Appropriate models
Greater salience
Sources of Alpha
• Existing extra-financial information overlooked
R&D intensity
Pro-shareholder corporate governance structures
Minority shareholder rights
Eco-efficiency
Human capital management
• New extra-financial information priced in slowly
Accruals as extra-financials
Corporate governance
Corporate Governance as Exemplar
0.2
0.15
0.1
Raw Returns
0.05
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
-0.05
-0.1
-0.15
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Months
Coming-into-Compliance
Always-in-Compliance
Never-in-Compliance
The Case for Diversity
• Fund manager
experience
Expand set of variables
Deliver new perspective
• Radars retuned
Relevant information
finding them
Sufficient diversity not
preordained
How Fund Managers Might Use
Extra-Financial Factors
• Individuals
Staff
Brand
Training
Power
Eco
Growth
Efficiency
Use a realistic model
Minority
Pricing
Rights
Apply filters
Consult a checklist
f
m
Corporate
Gov’nce
Equity
Value
g
ROIC
l
k
h
i
j
• For organisations
Join EAI
Develop in-house capability
Profit
R&D
Margins
Cost
Climate
of
Change
Capital
M&A
Deliver data in usable form
Encourage desired
behaviours
A Partnership for Investing
•
e
e
e
e
Explain contribution of extra-
Staff
Training
e
Eco
Efficiency
financials
Enable comparison
Communicate consistently
Minority
Rights
e
e
f
e
Corporate
Gov’nce
CEOs and CFOs
m
Equity
Value
ROIC
l
•
g
k
Trustees and consultants
h
i
j
Climate
Change
R&D
M&A
•
Develop indicators of short-termism
Gather evidence
Check quality of data
Review models
Build necessary resource
Unions
Reject dogma
Focus on systemic issues
The “Additional” Prize
• Permanent gains factored into higher
asset prices
Productivity effect
Growth effect
Risk effect
• Better alignment of investment
processes with long-term needs
End beneficiaries
Investee companies
Getting to Here from There
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Getting to Here from There
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Conclusion
• We put the “extra” in “extra-financial
factors”
Leaving alpha available
Misallocating capital
• EAI addresses oversight at source
– Redefines salience
– Promotes diversity
• A new generation of investor emerging
Informed partnership
Additional prize
The Lexicon of Investing
“When an investor systematically
integrates all relevant variables
into their decision making there is
no such thing as an extra-financial
factor: just enhanced analytics.”
Hendrik du Toit
Seeing What We Expect to See
Corporate Governance as Exemplar
10.00%
9.50%
9.00%
8.50%
8.00%
7.50%
7.00%
6.50%
y-1
y
Always-in-Compliance
y+1
Coming-into-Compliance
y+2
y+3
Never-in-Compliance