November 2011


DetectiveThere is surprisingly little statistical evidence proving a correlation between corporate governance and investment returns. But lessons can be learnt from a concept unique to Brazil. Stefanie Eschenbacher takes a closer look.
Anecdotal evidence from Brazil suggests that investing in companies with superior standards of corporate governance does result in higher returns. A listing segment of the BM&F Bovespa, the Novo Mercado, is specifically designed for companies that voluntarily adopt a ertain standard of corporate governance and transparency. The concept, which was created in 2002, is based on the premise that stock valuation and liquidity are positively impacted by shareholder’s rights and by the quality of information. According to a report by the World Bank’s International Finance Corporation, entitled Novo Mercado and Its Followers, these companies have outperformed their peers over time. São Paulo-based Victor Crisol Arakaki, a Brazil equities investment director at HSBC Global Asset Management, says his team clearly favours companies with higher levels of corporate governance. “We need to make sure that the sustainability of returns and the operational performance of the company is in line with our expectations,” he says. “In our investment process, we provide a discount to companies that operate under lower standards of corporate governance.” The HSBC GIF Brazil Equity fund holds a total of 40 stocks, 17 of which are listed on the Novo Mercado. The majority of the other 23 companies do not adhere to the Novo Mercado because they do not comply with the requirements of a unique share class. Carlos de Leon, manager of the Allianz RCM Brazil fund, has a similar opinion. Like Arakaki, he favours Novo Mercado companies but finds also compelling investment opportunities elsewhere. De Leon holds Companhia de Concessões Rodoviárias, the largest toll road operator in Brazil and the first company listed on the Novo Mercado. It is one of his highest conviction holdings and the prime example of a Novo Mercado company. Yet he says when it comes to performance, there are equally attractive stocks outside the Novo Mercado. Rapidly growing AmBev, which is the largest beverage company in Brazil by market share, is such an example. De Leon says with strong balance sheets, pricing power, growth projections and its market dominance, it ticks all the boxes when it comes to numbers. George Dallas, director of corporate governance at F&C Investments, has been studying emerging markets more indepth since the 1990s. He says many countries have seen positive structural changes. Apart from Brazil, he also singles out South Africa as an emerging market where companies tend to have a higher standard of corporate governance. “The introduction of corporate governance codes in many emerging markets has strengthened the approach to corporate governance,” he says, adding that investors can use their vote to influence company decisions. Conceding that academic evidence on the positive impact on stock market returns is still difficult to provide, Dallas highlights that bad corporate governance creates risks. “Maybe good corporate governance does not necessarily create outperformance,” says Dallas. “But bad corporate governance creates problems for investors. The question is: could bad corporate governance result in underperformance?” Matt Christensen, the global head of responsible investment at Axa Investment Managers, says his team has found evidence of high corporate governance making a positive contribution to returns. He is unable to disclose specific performance data for funds or individual stocks owing to the sensitivity of information, but says Axa has recognised the positive impact of environmental, social and governance factors and, therefore, recently decided to devote more resources to this side of the business. Apart from the Novo Mercado in Brazil, it is difficult to obtain reliable data proving a correlation between corporate governance and stock market returns. The International Finance Corporation has also reviewed an approach adopted by Romania in 2005. Romania requested the Novo Mercado’s standards and left it to the companies’ discretion to apply them. The Romanian Corporate Governance Codes and Principles and the Transparency Plus Tier (T+ Tier) were made mandatory for listed companies. “The result in Romania has been a near failure given that only one company had applied to be listed on the T+ Tier through 2006,” the review found. “Why? Romania’s capital market was not prepared to implement corporate governance standards. The positive attitude of the local issuers towards such standards was overestimated.” Whatever the specific reasons to the success of Brazil’s Novo Mercado and the failure of Romania’s T+ Tier are, they should give investors food for thought. Investors should also consider how they can demand higher standards of corporate governance using their vote at company level. ©2011 funds europe

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