This article was first published in the November 2013 International edition of Accounting and Business magazine.
The financial crisis saw many institutional investors catch a severe cold, undermining their confidence in the corporate reporting of the companies they had invested in. Three leading investors came together at Accounting for the future, ACCA’s global virtual conference, to discuss how that trust can be rebuilt.
Robert Talbut, chief investment officer at Royal London Asset Management, argued that one critical factor in the lead-up to the financial crisis was that investors placed too much reliance on market prices. ‘The belief was that if the markets have generated price A, then price A must be correct and we don’t need to apply any thought, judgment or criticism,’ he said. ‘Just blindly accepting market-generated prices led to some pretty perverse outcomes.
It led people to invest in certain assets and to hold assets at unrealistic prices that didn’t reflect economic reality.
‘One of the things we have learnt since the financial crisis is the need to be a lot more sceptical. We have to encourage people to exercise professional judgment and make sure that the prices being used really do stand up to scrutiny.’
David Stewart, chief investment officer at Santander Asset Management, pointed out that once every decade or so investors get a wake-up call – a smaller or larger crisis that reminds them they cannot rely wholly on market prices. ‘A whole new generation learns the hard way why
it’s called an equity risk premium,’ he said. The crisis triggered a distrust of corporate reporting, with investors recoiling from their earlier complacency. ‘In the aftermath of this crisis, that’s been more pronounced because it was a more intense experience,’ he said.
But Samantha McConnell, chief investment officer at the IFG Group, said that not all investors made their decisions from a ‘deep dive’ into the annual report. ‘Different types of investors, such as hedge funds, are looking for different things.’ It is the fact that investors have different agendas which has been behind part of the volatility in markets since the financial crisis, McConnell argued.
So, is it possible for corporate reporting – in particular, the annual report and accounts – to satisfy the dramatically diverse agendas of these different investors?
Talbut said: ‘We have to decide who the primary audience for financial statements is. Other people may use them, but the emphasis must be on the primary user and that should be investors who are longer-term providers of capital.’
Investors vs traders
McConnell agreed it was difficult, if not impossible, to reconcile the corporate reporting needs of long-term capital providers and short-term stock traders. ‘You should decide who the main users of financial statements are and gear towards that group,’ she said. ‘If you try to meet everybody’s needs, you’re not going to meet anybody’s.’
It was, she suggested, about getting back to fundamentals, with cashflow as king. She pointed out that ultimately cashflow drives share value and argued that current cashflow statements are not as helpful as they could be.
There were some strong criticisms of quarterly reporting. Stewart said some traders focus more on other investors’ reactions to quarterly reports than on the fundamentals those reports reveal. ‘As investors, we can look at our portfolios in the morning and if we don’t like them, we can press a button and change them immediately.
Companies don’t work like that, and the extent to which a quarterly snapshot should be used by investors to make fundamental decisions is deeply questionable.’
Talbut said quarterly reports should be scrapped – the quicker the better. ‘I think they have been one of the most damaging influences on the way management have managed businesses and the way in which investors have judged companies that we’ve seen in the last 25 years,’ he said. ‘The idea that we should be asking management to say how their business is going to perform in the next quarter – and to make sure that they hit the number – is mindless. It just harks back to the view that more information, more frequently, must be a better world, whereas what we want companies to do is to think about long-term sustainable value creation – and that’s not on a one-quarter basis.’
But McConnell pointed out that some investors, such as traders, use quarterly reports for trend analysis. ‘It comes back to the point that there is not a homogeneous group of investors,’ she said. ‘Long-term investors could say they would take quarterly reports or leave them, but other investor types will say that they are absolutely fundamental to the way in which they make money. So companies need to look at who are the holders of their share capital or debt and work out what is best for the investors in their firm.’
The three generally welcomed moves towards integrated reporting but had some reservations about how easy it would be to introduce. Talbut suggested that it could provide a better-quality picture of what is happening in a business.
But Stewart was concerned it could become too prescriptive and that companies would then ‘game it’. He said: ‘There is an argument for keeping things deliberately imprecise or subjective to allow analysts and portfolio managers to interrogate companies on what they think is important. That increases the efficiency of the share price mechanism through their subjective judgments.’
Finally, chairman Ian Welch, head of policy at ACCA, drew investors’ attention to the significance of the audit. McConnell argued there is cynicism about the value of the audit following some publicised shortcomings during the banking crisis. There should be oversight and regulation of the audit process, she argued, because people would have no reason to change their behaviour otherwise. ‘But the audit does add value,’ she said, ‘and it should pull managers back to making accounts that give a true and fair view of where their company is.’
hot topics on demand
All the sessions in last month’s Accounting for the future conference were recorded and are available as on-demand webcasts and videos for finance professionals to watch at their convenience.
The week-long event explored the role of finance professionals in building a strong and sustainable global economy. Among the sessions and live webcasts were the following:
- Creating value through leadership and corporate governance
- Board-driven internal audit and enterprise risk management: next-generation assurance
- Understanding the investor: the future of corporate reporting
- Integrated reporting: taking the first steps
- Critical success factors in transforming the finance function
- Future CFO career paths
- Following the rules/changing the tools: the change challenge of finance transformation
- Technology trends and the impact on the profession
- 100 drivers of change for finance and business
- Ready for growth? A checklist for FDs
- Using the crowd to punch above your weight