By Nick Anderson
As a manager of sustainable investment funds, how companies navigate the challenges in a world facing significant structural change is very important.
Material environmental and social developments present both risks and opportunities across the corporate sector. Recent evidence from the U.S. suggests management teams that are more attuned to long term environmental and social developments are also judicious in their allocation of capital. They are simply good managers.
There are plenty of ways to judge executives but history is always a fine place to start. Even when investors choose to focus on environmental, social and governance issues, the financial performance of a company remains an important consideration. For the Henderson SRI funds we focus on companies that can grow sustainably, in all respects. This includes the sustainability of cash flows and an appropriate allocation of capital.
Companies formally report their financial performance to shareholders in the report & accounts. Many of us think of accounting as being all about the numbers, the reporting of revenues and profits, assets and liabilities; together with the all detailed notes and assumptions that support the headline figures. In a slightly dismissive manner, we sometimes refer to accountants as “bean counters”. But at the heart of the discussion about the future of accounts, and financial reporting more generally, is a debate around concepts and words which runs much deeper than the numbers.
The accounts for most quoted companies outside of the U.S. are based on standards set by the International Accounting Standards Board (IASB). At the very top of the IASB’s hierarchy of is its conceptual framework. This sets the overriding principles on which all other accounting standards are based. Heated debates surround the future of the conceptual framework. Should companies be prudent when reporting or should in their accounts on a neutral basis without any bias? To what extent should assets and liabilities reflect current market values or be based on historic transaction values? And, even more fundamental, what is the purpose of financial reporting?
The debate over the primary objective of financial reporting has been a hot topic within standard setting circles. Should this be to help investors in their buy, hold or sell deliberations? Or should it also incorporate the principle of holding management to account as stewards of shareholders capital. Much of this is semantics. While formally promoting stewardship to a primary objective may make us feel better, in practice it’s difficult to think of any information that would help investors assess whether management have been good stewards that isn’t also useful in reaching buy, hold or sell decisions.
Investors, portfolio managers and analysts, have been at the periphery of the debate when accounting standards are devised. For preparers and auditors, financial performance is much more of a focus whereas there are many factors that can influence the long term direction of security prices. Towards the end of 2014, the IASB launched its Investors in Financial Reporting programme, a partnership with some of the world’s leading asset managers and owners designed to foster greater investor participation in standard setting.
As a founding partner in the programme, Henderson welcomes the initiative and is committed working with the IASB, to develop a richer dialogue between standard setters and the users of financial reports. In our rapidly changing world there are many important factors for investor to consider; both traditional financial metrics but also social and environmental issues. High quality reporting clearly has a critical role to play, through financial numbers and the accompanying narratives, to help investors better understand the performance and prospects of companies. We live in world of scarce resources and better corporate reporting should help ensure that these are allocated in an efficient and sustainable manner.
Nick Anderson is head of equity research and a fund manager at Henderson Global Investors
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