Corporate Governance
Performance Presentation Standards
Key Elements of Performance Presentation Standards
Corporate Governance: Definition, Principles, Models, and Examples
Good corporate governance can benefit investors and other stakeholders, while bad governance can lead to scandal and ruin.
Corporate governance is the system of rules, practices, and processes by which a company is directed and controlled. Corporate governance essentially involves balancing the interests of a company’s many stakeholders, which can include shareholders, senior management, customers, suppliers, lenders, the government, and the community. As such, corporate governance encompasses practically every sphere of management, from action plans and internal controls to performance measurement and corporate disclosure.
Overview
Introduction
Objectives
1.0 Corporate Governance
1.1 Definition
1.2 Why has Corporate Governance become Important?
1.3 Corporate Governance for Companies
1.4 Corporate Governance for Investors
1.5 Corporate Governance for Fund Management Companies
1.6 Summary
2.0 Performance Presentation Standards
2.1 Background
2.2 Why are Performance Presentation Standards Important?
3.0 Elements of Performance Presentation Standards
3.1 The Creation and Maintenance of Composites
3.2 Calculation of Returns
3.3 Presentation of Results
3.4 Disclosures
3.5 Verification
Overview
Here, we look at two topical areas:
(a) Corporate governance and
(b) performance presentation standards – relevant to the industry.
Objectives:
At the end of this study, you should be able to:
(a) define ‘corporate governance is important
(b) describe why corporate governance is important
(c) appreciate the important of voting at meetings of shareholders
(d) appreciate the need for investment performance presentation
(e) list the key elements likely to be included within performance presentation standards
(f) define a ‘composite’ and describe how composites may be constructed
(g) list some factors to be taken into account in calculating investment returns
(h) recognise the need to properly present performance to clients and prospective clients and to have performance verified.
Corporate Governance
1.1 Definition
Corporate governance is a generic term covering issues associated with business management practices and the structure of a company’s board of directors. The Cadbury Committee defined it as the system by which companies are directed and controlled’.
While the issues associated with corporate governance are common to all companies — including the operation of a company involved in fund management — what is particularly relevant to a fund management company is the role it can play in relation to the corporate governance of the companies in which it invests on behalf of its clients.
From an investor’s perspective, corporate governance relates to the degree of influence which should be exerted over companies by their shareholders (in the case of some institutional investors, if necessary, through their appointed fund management companies) with the objective of advancing their financial interests.
Such influence is usually (but not always) through the exercise of voting rights or proxies at company meetings (particularly annual general meetings) and is directed at the way companies are governed rather than the way they are managed.
Corporate governance, from an investor’s perspective, involves the issues facing the board of directors of a company (for example, the interaction between the board and senior management); and the board’s relationships with investors (owners) and others interested in the affairs of the company, such as corporate regulators,
creditors, lenders, investment analysts, and auditors. Corporate governance also involves concerns over factors affecting corporate performance (which in turn affects investment returns to investors) such as strategy formulation and policy making.
1.2 Why has Corporate Governance become Important?
The rise of the institutional investor (for which fund management companies often act) is usually regarded as the most important development in corporate governance.
In many overseas markets institutional investors have realised that the only avenue available to them in relation to an under-performing company is to encourage change through active involvement (i.e. voting) in issues raised at company meetings.
This is because institutional investors, who individually may own a large proportion of a company’s share capital, and who together may own the majority of the issued share capital of a company, cannot simply sell their investment through the market.
While ownership of share capital may be much less concentrated than in other countries, Malaysia’s markets are relatively small and many shares are thinly traded.
Institutional investors in Malaysia therefore face a similar problem to that faced by institutional investors in much larger overseas markets.
While the role of the institutional investor in Malaysia’s stock market is today relatively small in comparison with many overseas markets, it is likely that the involvement of fund management companies (on behalf of institutional investors) in issues of corporate governance is likely to grow significantly in future.
Corporate governance, as an issue, is particularly relevant to those clients of fund management companies who themselves represent others. For example, the trustees of a pension fund advised by a fund management company represent the interests of the funds members (employees and retirees), and have a fiduciary responsibility towards them. The trustee-appointed fund management company, too, has a fiduciary responsibility toward its client and must, as part of its role, consider corporate governance issues in relation to the companies in which it invests.
As well as having a keen interest in those aspects of the governance of companies which directly affect financial performance (and therefore investment returns to investors), funds management companies should also consider questions such as the accountability of management and the equitable treatment of investors in terms of sharing the rewards between management and investors.
1.3 Corporate Governance for Companies
A number of attempts have been made to identify what constitutes ‘good’ corporate governance. In 1992 in the UK, the Cadbury Committee, set up following several high profile corporate failures, suggested several guidelines which together constituted the ‘Cadbury Code of Best Practice for the governance of listed companies. The London Stock Exchange subsequently introduced a listing rule which required all companies, as a condition of continued listing, to disclose in their annual reports the extent of their compliance with the Code and their reasons for non-compliance. The Cadbury Committee’s guidelines were subsequently followed by the Greenbury Report on Directors Remuneration in 1995, the Hampel Committee on Corporate Governance in 1998 which produced the Combined Code, and the Higgs Review of the Role and Effectiveness of Directors in 2003. These subsequently led to further revisions on the guidelines on corporate governance.
Australia has followed a similar route to that of the UK. The structure of corporate governance and the responsibilities of directors were considered in a booklet Corporate Practices and Conduct’, and in 1995 the Australian Stock Exchange (ASX) introduced a listing rule that required all listed companies to comment in their annual report on their corporate governance practices. In March 2003, The ASXCorporate Governance Council, which was formed in August 2002, released its Principles of Good Corporate Governance and Best Practices Recommendations, representing the most comprehensive statement of best practice in Australia. The guidelines require listed companies to adopt its recommendations, failing which, explanations would be required.
In the United States, institutional investors have played a significant role in encouraging good corporate governance. One in particular, the California Public Employee Retirement System (CalPERS), has been noticeably successful in encouraging good corporate governance. In one study of 13 companies, CalPERS compared the investment performance of those companies prior to its involvement with the companies with the performance after it had become involved. In a five year period prior to CalPERS’ involvement, the companies underperformed the market by 63.5%; in the period of up to five years, during and after shareholder pressure on corporate governance issues had been imposed, outperformance of the
market by 89.1 % had been achieved.
In Malaysia, the issue of corporate governance is currently addressed in the Securities Commission (SC) Corporate Governance (Blueprint) which was launched on 8 July 2011. The Blueprint provides the action plan to raise the standards of corporate governance in Malaysia by strengthening self and market discipline and promoting greater internalisation of the culture of good governance. It engenders a shift in corporate governance culture from mere compliance with rules to one that more fittingly captures the essence of good corporate governance; namely a deepening of the relationship of trust between companies and stakeholders.
The Blueprint focuses on six connected themes of the corporate governance ecosystem namely shareholder rights, the roles of institutional investors, boards, gatekeepers and influencers, disclosure and transparency as well as public and private enforcement. The recommendations in the Blueprint will be implemented over a five year period.
The Malaysian Code on Corporate Governance 2012 (MCCG 2012) is the first deliverable of the Blueprint and supersedes the Malaysian Code on Corporate Governance 2007. The MCCG sets out broad principles and specific recommendations on structures and processes which companies should adopt in making good corporate governance an integral part of their business dealings and culture.
The MCCG 2012 focuses on clarifying the role of the board in providing leadership, enhancing board effectiveness through strengthening its composition and reinforcing its independence. It also encourages companies to put in place corporate policies that embody principles of good disclosure.
The MCCG 2012 is arranged as follows:
Principles
The principles of MCCG 2012 encapsulate broad concepts underpinning good corporate governance that companies should apply when implementing the recommendations.
Recommendations
The recommendations are standards that companies are expected to adopt as Part of their governance structure and processes. Listed companies should explain in their annual reports how they have complied with the recommendations. As there is no ‘one size fits all’ approach to corporate governance, companies are allowed to determine the best approach to adopting the principles. Where there is non-observance of a recommendation, companies should explain the reasons.
Commentaries
Each recommendation is followed by a commentary which seeks to assist companies in understanding the recommendation. It also provides some guidance to companies in implementing the recommendation. Although some of the commentaries provide examples and suggestions, these should not be taken to be exhaustive.
1.4 Corporate Governance for Investors
While institutional investors have been involved in moves to establish guidelines on corporate governance for companies to follow, at the same time guidelines for institutional investors have also been established.
In 1991 in the United States, the ‘New Compact for Owners and Directors’ not only established several principles applicable to directors but also several applicable to shareholders. These principles were:
(a) institutional shareholders of public companies should see themselves as owners not just investors
(b) shareholders should not be involved in the conduct of the company’s
day-to-day operations
(c) shareholders should evaluate the performance of the directors regularly
(d) in evaluating the performance of directors, shareholders should be informed
(e) shareholders should recognise and respect that the only goal common to all shareholders is the ongoing prosperity of the company.
In the UK the Institutional Shareholders’ Committee has suggested that:
(f) institutional investors should encourage regular, systematic contact at senior executive level to exchange views and information on strategy, performance, board membership and quality of management.
(g) institutional investors should support boards by a positive use of voting rights, unless they have good reasons for doing otherwise. Reasons for voting against a motion should be made known to a board beforehand.
(h) institutional investors should take a positive interest in the composition of boards of directors.
(i) in all investment decision-making institutional investors have a fiduciary responsibility to those on whose behalf they are investing, which must override other considerations.
In Australia, the rights and obligations of shareholders set out in ‘Corporate Practices and Conduct’ had incorporated many of these suggestions but added that:
(a) the responsibility of a shareholder increases with the size of its shareholding
(b) in relation to the composition of the board, shareholders should take a positive interest where there are ‘concentrations of decision-making power which are not formally constrained by checks and balances appropriate to the particular company’, and in the ‘appointment of a core of non-executive directors of appropriate calibre, experience and independence’
(c) shareholders should ‘take a positive interest in the report and competence of auditors and where appropriate, be prepared to ask questions of the auditor’.
Shareholders should also take a positive interest in the appointment of a board’s Audit Committee
(d) in consideration of insider trading laws, shareholders should not seek to receive price sensitive information which is not available to the market generally’.
In Malaysia, the role of institutional investors is discussed in Chapter 2 of the Blueprint.
1.5 Corporate Governance for Fund Management Companies
The Financial Services Council (FSC) represent Australia’s retail and wholesale funds management businesses, superannuation funds, life insurers, financial advisory networks, trustee companies and public trustees. FSC’s Standards and Guidance Notes ensure the promotion of industry best practice.
Compliance with the FSC’s Standards is compulsory for all full FSC members while compliance with the FSC’s Guidance Notes is voluntary, but strongly encouraged.
Both the FSC’s Standards and Guidance Notes can be accessed at www.fsc.org.au.
1.6 Summary
We have seen that fund management companies have a responsibility to their clients to become involved in the investments which they manage. The extent of this involvement excludes direct involvement in the policies or operations of the companies in which investments are made. However, it does extend to ensuring that the boards of such companies act in accordance with the principles of ‘good’ corporate governance. Similarly, fund management companies should recognise that they also have an obligation to the boards of companies in which they invest.
2 Performance Presentation Standards
2.1 Background
We have seen in previous topics that both the Capital Markets and Services Act 2007 (CMSA) and the Securities Commission impose various client disclosure requirements on fund management companies. The Investment Management Agreement between a fund management company and a client will generally incorporate provisions relating to the reporting and disclosure obligations of the fund management company. We have also noted that a Code of Ethics or Conduct applicable to those working in the funds management industry may include requirements relating to the disclosure of clients of various matters that may affect the management of their funds.
An important element of disclosure is that relating to the presentation or past investment performance — either for the purpose of reporting to a client the actual investment returns achieved by the fund management company in respect of a single portfolio, or in relation to the presentation of the fund management company’s past performance for the purposes of attracting new client portfolios.
2.2 Why are Performance Presentation Standards Important?
Performance presentation standards are one aspect of a Code of Ethics or Conduct that may be applied to a fund management company. (It would be useful at this stage to re-read the part of Topic 5 that explains the importance of such a Code.) To avoid mis-representing to clients and prospective clients a fund management company’s performance, it is important that investment performance be presented fairly. It is also important that all funds management companies present their investment performance in a similar manner — otherwise a client or prospective
client could be misled in relation to the comparative investment performance of the fund management company.
The Global Investment Performance Standards (GIPS), created and administered by the CFA Institute for example, are devised to provide a universal, voluntary standards to be used by fund management companies for quantifying and presenting investment performance that ensure fair representation, full disclosure and apples-to-apples comparisons.
3 Key Elements of Performance Presentation Standards
Performance presentation standards, among others, would contain the following key elements.
3.1 The Creation and Maintenance of Composites
It is clearly meaningless (and therefore misleading) to compare the investment performance of a Malaysian equities portfolio with that of an international equities portfolio. For this reason, performance presentation standards should include guidance on the formation of ‘composites’ i.e. the aggregation of portfolios into a single group that is representative of a particular investment strategy, style
or objective.
The formation of a composite starts at the fund management company level i.e. all the client portfolios managed in the same manner are grouped to produce an asset-weighted composite return. The performance of the composite can then be more meaningfully compared with the return achieved by other fund management companies managing client portfolios in the same way.
Once a fund management company has determined its criteria for composite
construction, client portfolios can be assigned to particular composites. All portfolios must be assigned to avoid an accusation that the resulting asset-weighted composite return has been manipulated (perhaps by the exclusion of grossly under-performing portfolios) and is therefore misleading.
An important factor in allocating a client portfolio to a composite is the discretion that the client allows the fund management company to have in managing that portfolio. Non-discretionary portfolios should not be included in discretionary portfolio composites since restrictions affect the fund management company’s ability to implement its preferred investment strategy.
3.2 Calculation of Returns
In achieving compatibility, uniformity in the calculation of investment returns from a portfolio is clearly important.
The generally accepted methodology in performance measurement is the time-weighted rate of return concept. It is not the intention of these notes to examine the basis of such calculations. However, such calculations generally take into account cash flows during the measurement period, the frequency of valuation, income accounting, the weighting of portfolios comprising a composite, treatment of expenses (including management fees) and taxation.
3.3 Presentation of Results
Once determined, the investment returns of composite portfolios should be presented in a manner that helps meet the objective of fair representation and full disclosure. To present short-term performance in such a way that prospective clients are misled as to the capabilities of the fund management company is clearly unreasonable. The GIPS standard generally require a minimum of five years’ performance record that meets its standard; with additional annual performance up to ten years thereafter. Annualised performances for periods of less than one year
are not allowed.
3.4 Disclosures
The GIPS standard requires performance to clearly label returns gross-of-fees or net-of-fees and shall stipulate the complete list and description of the firm’s composites. Details of currency used to express performance, the known inconsistencies in the exchange rates used among the portfolios within a composite, between the composite and benchmark must also be disclosed.
Disclosure requirements also include consideration of the effect of leverage and derivatives used in the management of client portfolios.
3.5 Verification
Finally, the GIPS standards require that fund management companies’ performance be independently verified and attested as such. Given the important decisions taken as a result of a consideration of a fund management company’s performance, this does not appear unreasonable.