Sounding the trumpet call of due diligence
Since the breaking of the Steinhoff saga, a lot of attention has been paid to corporate governance and the way that companies are run.
While it is important for this to take place in order to ensure that companies fulfil their obligations to investors, investors also have a responsibility to do due diligence into whether the company is worth investing in.
According to asset management company Mercer, the latter is unfortunately lacking in the market.
Raising the bar
Nigel Morriss – Head of Operational Risk for the India, Middle East, Turkey and Africa (IMETA) Region Mercer – believes that the bar needs to be raised when it comes to operational due diligence.
“There is a lot of money at stake when it comes to corporate scandals. The Bernie Madoff scandal alone cost US investors $50 billion. Looking locally, Steinhoff cost investors close to R35 million. In many cases, not enough is being done to mitigate non-investment risks,” said Morriss.
He added that the problem with this is that the full extent of the risks are not known. Morriss drew a parallel to an iceberg to explain his point.
“In almost all cases, the important risks (which are very costly when looked at in isolation) are clearly visible to the investor. Companies go to great pains to settle investor fears by telling them that these issues are being addressed. However, there are a lot of risks which sit below the surface, unseen, which can cumulatively cripple investors. Red flags were raised about the Maddoff and Steinhoff scandals long before they drew media attention, and yet, they proved to be costly,” said Morriss.
Important trumpet call
Crises such as Steinhoff are not only crippling from an economic standpoint, it erodes trust and forces the public to ask important questions regarding the ethics and integrity of the companies that they place their trust in.
But it is not how you get knocked down, it is about how you get up after the fall. Morriss said that, while regrettable, the Steinhoff saga should be an important trumpet call for the South African market to focus on due diligence.
“Many regulators are taking a more proactive approach when it comes to market governance. Perhaps companies should take the same approach when it comes to due diligence. Would you, as a fund manager or financial adviser want to know about the potential of things to go wrong before investing? This could have saved a lot of investors a lot of pain during the Steinhoff saga,” said Morriss.
Regulatory worries
“One of the concerning aspects when it comes to due diligence is that there are no markets in the world where there is regulation in place to force fund managers and companies to carry out corporate due diligence,” said Morriss; however, he pointed out that there are a lot of markets in the world where fund managers are carrying this out of their own accord.
Something that is possibly of greater concern is the fact that while offending companies do face significant fines, life goes on for them after the dust settles. Are we doing enough to punish offending companies?
“I think we are moving towards a place where a lot more is being done from a regulatory point of view. In the past, when there are crises in the market, we tend to look at similar cases from around the world and benchmark punitive measures against those handed down in these cases. There is an additional control measure on the horizon in the UK. The General Data Protection Regulation (GDPR) will change the face of asset management as we know it. If there is any inkling of a crisis hitting the markets, they would be compelled to inform advisers to send out a warning call to their clients. Failure to do so will result in serious repercussions,” said Morriss.
What needs to be done
Mark Lindhiem, Head of Strategy at Alexander Forbes Investments, said that not only was the Steinhoff saga a trumpet call, but it shook the very foundations of the asset management industry.
He added that there are a lot of asset management companies that are now taking a more serious approach when it comes to due diligence. Further, they are far more cautious when any red flag is raised.
Far more needs to be done in the market. Specialised skills are needed to address the hidden risks that exist within companies. “Often, a corporation such as Steinhoff will say that they do undertake their own due diligence, but this is often not being done by qualified people. Scrutinise the message that companies are giving you,” said Morriss.
What about the investor?
Being forewarned is being forearmed. There is a lot that asset management companies and advisers can do to highlight the existence of red flags to clients.
However, the sole responsibility does not rest with the asset manager or adviser. Clients can also play their part in making sure that a crisis like Steinhoff does not blindside them again.
Lindhiem said that there is no such thing as a risk-less investment portfolio and clients should be looking at their portfolios with a very critical eye. If they see something that looks to good to be true, then it often is.
“A lot of this has to do with financial education. While this type of education is a major issue in South Africa, clients can take basic steps. They need to trust their gut feel when it comes to the promises that a company makes to them. Further, clients need to talk to their advisers about diversification. Advisers also need to stress test client portfolios to make sure that they can weather any possible storm that approaches them,” said Lindhiem.
Editor’s Thoughts:
Do you feel that there needs to be an increased focus on due diligence? Who is responsible for this, is it asset managers or the companies they trust and invest in? Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts [email protected].
