In the Q&A below, Rudi Minbatiwala the head of our Equity Income Team provides some insights into the team’s approach to responsible investment, stewardship and the integration of environmental, social and governance (ESG) issues into both investing and product design.
An ESG issue which is often discussed by investors relates to changing demographics. Your strategy is designed specifically to help people managing retirement savings for longer given increased life expectancy. Can you explain how your strategy relates to this demographic issue?
The equity income strategy has been developed to assist with the challenge of addressing longevity risk. Longer life expectancy does bring with it financial challenges around how to extend the number of years retirement savings can support future spending requirements.
As a result, one component of managing the longevity risk (as part of a combination of insurance and investment strategies) is the need to continue to generate attractive real returns over the long term. However, this requirement to maintain a meaningful allocation to risky assets to earn a higher rate of return conflicts with the desire to limit the degree of capital volatility as investors migrate to retirement.
An allocation to a well-constructed equity income strategy can play a role in managing this conflict as the strategy seeks to reduce the size of the peaks and troughs over the course of a market cycle as well as generate above market income returns. This focus on narrowing the range of outcomes is a change of thinking compared to traditional accumulation investment strategies.
Rather than thinking about expected returns, there is value in thinking about the impact of the potential range of returns that an investor may experience during the period approaching and following retirement. Effectively, as investors we have to manage not just whether a retiree’s savings are expected to be sufficient to fund their longer post-retirement living, but also manage the path of those returns by which this objective is achieved.
As the income needs of investors continue to become a major focus point, does this introduce any new governance issues that should be considered for companies you invest in?
It is true that some investors now place a significant focus on the composition of returns in addition to the size of the overall return. Many listed companies are well aware of this trend. One governance issue that this can introduce requires us to ensure that companies continue to have a long-term perspective when it comes to capital decisions between paying dividends and re-investing in the business to support future growth.
Given executive incentives are often linked to Total Shareholder Returns (TSR) measures, it is valuable to consider if capital management decisions such as increasing dividends or undertaking share buybacks are aligned to long-term value creation, rather than simply an opportunity to support the company’s share price in the near term in order to meet TSR performance hurdles.
"It is valuable to consider if capital management decisions such as increasing dividends or undertaking share buybacks are aligned to long-term value creation, rather than simply an opportunity to support the company’s share price in the near term."
What do you see as the benefits of being part of the broader CFSGAM business generally, but also in terms of its strong focus on responsible investment and stewardship?
The Equity Income team works in partnership with other investment teams within CFSGAM to deliver objectives-based investment strategies to our clients. As part of this approach, the team draws upon the analyst research from various investment teams as inputs into the stock selection process. This will usually incorporate the identification of any relevant ESG issues identified by the teams, which is typically based on a rigorous company meeting program. In addition to their own analysis, investment teams also draw on the insights of external ESG research providers, which is compiled by our dedicated Responsible Investment team.
An important component of the research and engagement process for companies in the investible universe is active direct dialogue with senior company management and chairpersons on material ESG issues identified. We incorporate much of this in-depth analysis when considering investments for the equity income strategy.
Through this process teams seek to gain comfort that a company’s senior management and board are aware of, and accountable for, the management of material ESG issues. Where we feel material issues are not being appropriately addressed we will work with the Responsible Investment team to develop an engagement strategy for the issue. This can then flow into our proxy voting and investment decisions.
For the Equity Income team, an additional benefit from being part of the broader CFSGAM business is the supporting infrastructure to undertake strategic research (thought pieces) on broader investment issues related to the design of outcomes-based portfolios. We consider this research, and the ability to share this research through client education, to be an important aspect of the stewardship of our client’s assets.
"The team draws upon the analyst research from various investment teams as inputs into the stock selection process. This will usually incorporate the identification of any relevant ESG issues identified by the teams, which is typically based on a rigorous company meeting program."
Equity investments are widely regarded as long-term investments. Therefore, does a focus on short-term income from equities conflict with responsibly investing with a long term investment perspective?
This is an interesting question because the concept of income needs to be thought about a little differently in equities compared to traditional income asset classes such as bonds, credit and cash.
Our investment philosophy recognises that income needs are an immediate requirement for many investors, but the process we undertake to meet this objective still has a long-term focus. Our research shows that while current dividend yields provide a reasonable indication of current period income, they provide a poor indication of long-term income generation. The key to maximising income from equities over the long-term involves a combination of yield and growth considerations together, not a focus on yield alone.
This integrated consideration of yield and growth means that a focus on maximising after-tax total returns should remain the foundation of an investment strategy seeking to generate high sustainable income from equities over the long term. Investors face a range of structural near-term and long-term challenges. It’s important that the design of objectives-based investment strategies provides a solution that addresses the short term objectives without compromising long term objectives.