Scottish Oriental Handbook: Part 1
Avoid: Investing in companies controlled by poor quality owners and managers
The handbook
Our investment approach is aimed at preserving capital and growing it sensibly. This approach has remained steadfast since the Company was established in 1995. In the fast-growing Asian region, there are several exciting stories or popular themes prevailing at any point of time, which promise attractive returns. These themes rarely stand the test of time and investing behind such opportunities comes with the risk of permanent loss of capital.
Therefore, our investment process starts by determining what we will not do.
Avoid: Investing in companies controlled by poor quality owners and managers
Our assessment of any business starts with the quality of its majority-owners and management team. We believe that those owners and managers which have a track record of treating other stakeholders poorly, ranging from their workers, suppliers or the communities in which they operate, will eventually compromise the interests of minority shareholders as well.
We prefer to invest behind family-owned companies, as families typically take a long-term view of building their businesses and are able to make counter-cyclical investments. In most cases, we don’t find ourselves to be aligned with state-owned enterprises (SOEs) which typically need to shoulder national service obligations which may not be in the interests of minority shareholders. However, assessing which families are worth backing and which we should avoid is key. After three decades of investing in Asia, we have built strong networks across countries in the region which help us determine the local reputation of management teams.
Our meetings with companies on the ground are supplemented by comprehensive checks with their suppliers, customers, distributors and competitors. In our experience, feedback from a supplier which indicates that a company habitually delays payments, or from a distributor that its management asks them to push sales aggressively just before the end of a quarter, tells us much more about the quality of a company’s financials than spreadsheets. We pay close attention to changes in the ownership and management of companies, as those are often pivotal points of change in the direction of travel for the business.
Case study: United Breweries
Navigating governance challenges and strategic transformation in India's beer industry
One such example is United Breweries, the dominant beer company in India with 54 per cent market share in the industry, led by its Kingfisher brand. For several decades, the business was majority-owned by the Mallya family. While United Breweries had built a market leading position under their leadership, we had several concerns.
The company’s board was poor quality, with several of the chairman’s friends and associates appointed as independent directors. This board permitted substantial related party transactions. We were also sceptical of our alignment with the promoter family, as the chairman had empire-building ambitions, having established a commercial airline, acquired a Formula-One franchise as well as a franchise in India’s domestic cricket league (Indian Premier League).
The listed company contributed to some of these endeavours through its large brand-building budget. Due to these governance concerns, we were not invested in the business despite an appreciation for its strong franchise and growth potential. A gradual change in ownership was initiated because the promoter family had taken on high levels of personal debt to fund its ventures. They used the sale of their shareholding in the listed company to repay some of this debt, which led to Heineken building its stake in United Breweries starting in 2008. Our meetings with Heineken’s representatives suggested that they were gradually appointing key management members to critical functions such as the chief financial officer, strengthening the quality of the board and terminating the related party transactions as they gained control.
This improvement in the quality of ownership and management gave us conviction to establish a position in the company in 2014. Since then, the company has grown consistently while strengthening its dominant position in India’s beer industry. We remain excited about its prospects.
Risk factors
Capital at risk. The value of investments and any income from them may go down as well as up and are not guaranteed. Investors may get back significantly less than the original amount invested.
Important Information
This document has been prepared for informational purposes only and is only intended to provide a summary of the subject matter covered and does not purport to be comprehensive. The views expressed are the views of the writer at the time of issue and may change over time. It does not constitute investment advice and/or a recommendation and should not be used as the basis of any investment decision. This document is not an offer document and does not constitute an offer or invitation or investment recommendation to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any material contained in this document.
Net Asset Value (NAV) performance is not the same as share price performance and shareholders may realise returns that are lower or higher than NAV performance.
This document is confidential and must not be copied, reproduced, circulated or transmitted, in whole or in part, and in any form or by any means without our prior written consent. The information contained within this document has been obtained from sources that we believe to be reliable and accurate at the time of issue but no representation or warranty, express or implied, is made as to the fairness, accuracy, or completeness of the information. We do not accept any liability whatsoever for any loss arising directly or indirectly from any use of this information.
References to “we” or “us” are references to First Sentier Investors.
In the UK, issued by First Sentier Investors (UK) Funds Limited which is authorised and regulated by the Financial Conduct Authority (registration number 143359). Registered office Finsbury Circus House, 15 Finsbury Circus, London, EC2M 7EB number 2294743.
Scottish Oriental Smaller Companies Trust plc (“Company”) is an investment trust, incorporated in Scotland with registered number SC0156108, whose shares have been admitted to the Official List of the London Stock Exchange plc. The Company is an alternative investment fund and has appointed First Sentier Investors (UK) Funds Limited as the alternative investment fund manager for the Company. Further information is available from Client Services, First Sentier Investors (UK) Funds Limited, Finsbury Circus House, 15 Finsbury Circus, London, EC2M 7EB or by telephoning 0800 587 4141 between 9am and 5pm Monday to Friday or by visiting www.scottishoriental.com. Telephone calls with First Sentier Investors may be recorded.
First Sentier Investors entities referred to in this document are part of First Sentier Investors a member of MUFG, a global financial group. First Sentier Investors includes a number of entities in different jurisdictions. MUFG and its subsidiaries do not guarantee the performance of any investment or entity referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk including loss of income and capital invested.
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