Kennox has a Stewardship Code which reads as follows:
Kennox takes its management and stewardship responsibilities seriously. As such, we believe it is important to remain up to date on issues impacting our investee companies, and to engage with them where appropriate. We assess any issue in terms of its impact to the long term value of an underlying company and thus the value of our clients’ holdings.
At Kennox we believe that good long-term performance of companies is directly related to their approach to good governance, ethical and environmental responsibility and consideration of social impact. As such, when specific SRI issues are identified Kennox will consider these in relation to other investment factors.
Our approach to stewardship and SRI is encapsulated in the following principles which are embedded in our investment philosophy:
What does that mean in practice? First and foremost for us at Kennox, this means to decide when to act and when not to.
Companies are complex, involving many moving parts, and are made up of multiple stakeholders, including employees, customers, shareholders, suppliers, as well as regulators and governments and the community at large. Any issue or decision will have many knock-on repercussions, which are almost always impossible to predict precisely. This unpredictability and uncertainty about the future is what makes business management an art and not a science.
Thus, the first point about engaging with a company is to do one’s best to understand the broadest context for that issue. What were the decisions that led to this point? Is there a good reason why this has come to pass? What are the repercussions of changes, across the entire group and across all the different stakeholders? When viewed from the perspective of the whole, how important is the issue, and how easy is it to institute a sensible solution? This is very similar in our minds to special interest groups in politics. Interest groups are essential to our political system, but their role is very different to the ruling elected party. To run a country involves considering the trade-offs of every decision and trying to find a best fit, even though that will be inherently imperfect. Listening to one group is important but it is the government, not the interest group, which has to weigh up the ramifications of action. Ditto the stewardship of a company. Shareholders have to be selective on engaging, and always remember the broader context so as not to cause more damage than improvement (“primum non nocere” – “first, do no harm”).
One of the traps that stewards have to be cognizant of is idealism. Whilst we continuously wish for a world with no environmental problems, no civil or labour strife, we are also wary of idealistic solutions, which often cause more problems. For example, we really wish that we didn’t need fossil fuels to run the modern economy. These degrade environments in their removal, and (most likely) cause global warming on consumption. Wouldn’t it be wonderful if we could just walk away from fossil fuels?
Yes, it would. But just because this is a lovely outcome doesn’t mean that it is possible. The cost to dropping all these energy sources would be beyond reckoning, and could possibly cause massive social disruption, including civil and international wars. This is a cost that we do not want to pay. This separation, of what is ideally desirable and what is pragmatically possible, always has to be at the front of one’s mind.
So when to engage? When an individual company is failing on a specific issue, such as environmental failings, is a very good time to engage. Thus we think that it is entirely appropriate to criticise companies about their failings and where they should and could be doing better, but it is not appropriate to “excommunicate” entire industries where there is no substitute.
When else to engage? One area where we often engage is where we try to encourage managements to make decisions that we feel many investors would disagree with – to focus making decisions that will best serve the company in the long term, and not take easy or soft decisions in the short term. Can the company resist temptation in the short term for a better outcome in the longer term? This would be our view on excess debt. Many companies dislike cutting dividends, even when they become uncovered and paying them means increasing debt. Perhaps worse is when companies leverage up to buy shares – something that is particularly prevalent in the US at present. It seems like a lovely idea when the times are good (as we feel they are now) but we will only know if it was clever in the future, possibly far out into the future. And there are significant risks – if servicing debt becomes a problem, it could be a big problem, which could involve loss of jobs, cutting of other corners, and even possibly the viability of the entire company.
We want to find the best way to engage, lightly or otherwise, to encourage companies to behave as a “good corporation” as described by the FT’s John Kay in his article of May 2015: “[The good corporation] pays workers a living wage; it does not engage in aggressive tax avoidance. It develops the skills and capabilities of its employees and does not bewilder customers with complex tariff structures. It earns profits, reinvests some and pays a dividend to shareholders. Its executives spend more time walking around offices and shop floors than sitting in the meeting rooms of investment banks. The good corporation contributes relevant expertise to the formation of policy but does not engage in lobbying on a scale that corrupts political decision-making.”
Most importantly, companies need patient and prudent shareholders. Their role is to be informed and balanced in their judgement, and to choose their engagements carefully. They are there when needed. When there is a reason to act, they should become very vocal and visible. Otherwise, they should remain in the background.
This is the key to stewardship – most of the time, patience, gentle encouragement and monitoring are the best courses of action. But a good steward must be ready and willing to act, sensibly, decisively and forcefully, when necessary.