Q. The Royal Commission has highlighted how bad culture can KO a company’s share price. How do you bring culture into your stock picking?

Environment, Social and Governance or ESG is part of the investment process rather than an asset class. We’ve recently seen through the Royal Commission into financial services the wealth destruction that can come when strong ESG principles are lacking. There is an increasing body of evidence that high ESG scores perform better than low ESG scores. Not only is about screening for ESG about managing risk and avoiding catastrophes in portfolios but it also provides better performing, more stable investments over time.

Data providers are increasing issuing ESG scores making it easier for investors to include ESG into the investment process. Here is a breakdown of Thomson Reuters ESG Score model.

Source: Thompson Reuters ESG scores methodology

Q. We know how culture can detract from performance. Give us an example of how culture can help performance.

Culture impacts on a number of areas including staff turnover, productivity and performance. IAG recently has started to encourage customers to the early lodgement of claims, following a disaster event. After the recent Sydney hailstorms at the end of 2018, the company sent text messages. Some of the benefits of doing this (beside helping the customer) were:

• Reduced fraud with early claims lodgement.

• Lock down supply labour and hence labour costs.

• Staff turnover (voluntary) improved from 15.2% in FY17 to 12.9% in FY18.

Managing staff turnover can provide a competitive advantage compared to peers and high staff turnover is an extra financial burden on the business. In addition, Human Capital Management (HCM) scores can be allocated to stocks. Positive HCM has outperformed lower scores over the past 10 years.

Q. Investors have known for a long time that there can be a correlation between what management does and the performance of a stock. Tell us more.

Investors have known for a while that insider buying or selling can be a harbinger of good or bad times for the business. While one director selling a substantial chunk of shares may be a slight negative for sentiment, two or more directors selling substantial shares can be a red flag for a period of underperformance.  Over the last few years, there have been many examples of where insider selling has impacted negatively on share price. Bellamy’s saw its then CEO and chairperson sell shares in August 2016, only to record a net loss for that particular calendar year.

Q. So where have we seen insiders recently buying or selling stock?

1.     Tassal Group Limited (TGR): Tassal chief Mark Ryan DUMPED half his stake. He had 360,378 shares before 18 February and then SOLD 200,000.

2.     Evolution Mining Ltd (EVN): Jake Klein SOLD $9.45million shares late last year.

3.     Computer Share Limited (CPU): Christopher Morris SOLD $8.1million shares

4.     Link (LNK) John McMurtrie BOUGHT another $1 million shares.

5.     Nine Entertainment Co Holdings Ltd (NEC): Birkrtu (Bruce Gordon) 8.9% to 14.1% in January.

6.     Adairs Ltd (ADH) Brett Blendy 12.3% to 15.3%.

Q. So what stocks should investors consider or avoid from an ESG perspective?

Given insider buying at NEC and LNK, both of those stocks should be on the radar of investors as well as IAG, which is seeing an improvement in staff turnover and some other initiatives to improve culture. As always, an ESG overlay should be included with other performance measures and incorporating future expectations.

This article was first published in The Switzer Report. Click here to take a free 21-day trial.