We’re sharing some key insights from an authoritative research article recently authored by our partners at Green Blue Invest, the ESG-focused arm of Cité Gestion Private Bank. For any investors with US equity exposure this will be of interest. As one of the most insightful reads of the year, it provides essential knowledge for navigating the complexities of equity investments and sheds some light on one of the key drivers of company performance: that of ‘Governance and Stewardship’.
For information about how to implement this strategy (SMA, Fund, Swap, etc) please do get in touch with us.
Introduction
The Market Neutral Good Governance Strategy is based on the principle that good governance is a key driver of superior company performance. The Stewardship Model, which has been in operation for over eight years, has consistently shown that well-governed companies tend to outperform the S&P 500 Total Return Index by an average of 5% gross per year. The well documented rise in the S&P 500 index is not a broad-based rally. It has been driven primarily by a small group of outstanding performers, the so- called “Magnificent 7”. The pertinent question, therefore, is whether all of the Magnificent 7 companies exhibit strong governance characteristics.
The Stewardship Model: Filters for Selecting and Not Selecting the Magnificent 7 Stocks
The strategy uses machine learning to analyze the annual reports (10-Ks) of S&P 500 companies published at the beginning of the calendar year to identify indicators of corporate culture and behavior. This process enables us to select the 100 “best managed” companies from the S&P 500 in April, and of course the 100 “least-well managed”. That’s the easy-to-understand basis of the market-neutral strategy. Based on the 10-Ks available as of April 2023, we see a recurring trend that suggests history often repeats itself in certain patterns. It turns out that not all of the Mag-7 are created equal when it comes to Good Governance.
The table shows that the Magnificent 7 companies each have unique elements in their DNA. The negative scores explain why META and TESLA were not included in the model. In addition, several key insights emerge from the analysis of the model…
Summary of findings
- Microsoft stands out as a leader among the Magnificent 7 because of its exceptional governance characteristics. Across the 12 dimensions of stewardship, Microsoft excels in 7 key areas: Accountability, Purposefulness, Trustworthiness, Harmony, Passion, Positiveness, and Innovativeness.
- Nvidia is emerging as a strong contender for the top spot. Currently, this founder-led company excels in two critical dimensions: taking care of customers and fostering a strong sense of identification with the company.
- Alphabet continues to be exceptionally well-managed and strongly influenced by its two founders. The company leads in the dimension of long-term focus more than any other in the Magnificent 7 group.
- Amazon has made remarkable improvements in its relationship with its employees. However, as a global retailer, it faces the challenge of satisfying its vast global customer base.
- Apple stands out for its proactiveness in managing risk. However, it lags in several critical dimensions, including long-term focus, employee trust and company identification, and prudence. If these areas remain weak, Apple’s competitive advantage could be compromised.
- Meta presents a contrasting picture. On the one hand, the company is exceptionally prudent in its use of leverage, but on the other, it faces significant stakeholder challenges, as evidenced by its low ranking on dimensions such as accountability, harmony, and positiveness. Much like Amazon’s struggles with customer care, Meta’s status as a social media company is naturally fraught with controversy, particularly in areas such as privacy.
- Tesla lags behind the other six companies in the Magnificent 7. Compared to the world’s best-run companies, such as Microsoft and others, Tesla ranks lowest on key dimensions such as Purposefulness, Passion, Innovativeness, and Proactiveness. It is important to note that investing in such volatile and competitive sectors can be tricky. There are risks and challenges, such as fierce competition and changing regulations, that can affect the performance of these big names.
That is why the Stewardship Model is proactive, tweaking the three filters – Resilience and Agility, Classical and Modern* – to stay on top. This research isn’t just a pat on the back for the research team behind this; it shows the power of focusing on governance when investing. While there is no foolproof method, the Stewardship Model’s approach, which tracks market trends and corporate actions, has a solid track record of picking winners over the years. This study underscores why good governance matters – not just for the companies themselves, but for building a strong portfolio and making smart investment decisions.
* Resilience and Agility: Different word lists are used to assess how well a company handles crisis, manages risk, and demonstrates prudence.
Classical: Uses word lists designed to capture a company’s beliefs, attitudes, values, and actions. The aim is to get an honest, up-to-date assessment of the company.
Modern: The word lists are updated annually to reflect the evolution of vocabulary and the latest and best practices. This is about keeping pace with societal and market developments and having a forward-looking approach.