“The greatest power is often simple patience.” E. Joseph Cossman – inventor of the ant farm.
Our investment philosophy is a long-term and a patient one. It offers patience to companies so that they might endure and overcome life’s inevitable ups and downs. Most companies are too myopic, too frantic, too reactionary. This is somewhat inevitable given the remarkably short periods of time that ‘investors’ hold stocks for on average.1 Thankfully, if one looks hard enough, plenty of patient companies can be found and portfolios populated with them. They come in a myriad of shapes and sizes, but a recurring theme is that of a solid anchor in the form of a controlling shareholder. They ignore the minute-by-minute din of financial markets. They refuse to manage their businesses on a quarter-to-quarter basis. They avoid knee-jerk reactions when faced with short-term problems. They do not overextend themselves in fear of missing out on the latest fad. They make long-term decisions to the benefit of many stakeholders besides themselves. They obsess over return of capital before worrying about return on capital. They recognise that the slower growing trees are often the ones that bear the best fruit. This article discusses some of our favourite ownership structures in emerging markets.
The most common type of anchor that we invest alongside is that of a controlling individual or family with an intergenerational mindset. This is most simple when a company is relatively young and is still managed or controlled by its founders. India’s largest business-to-business classifieds company is one such example. It is controlled by its founder and in contrast to many internet entrepreneurs, his unwavering focus has been to build a successful business using internally generated cash flows while maintaining a strong balance sheet. His company has a market share of over 60%, with 7 million listed suppliers and over 140 million listed buyers.2
Matters become rather more complicated as decades pass and families grow. A French company with a highly profitable Chinese subsidiary is the world’s largest cookware and small kitchen appliances company. It remains controlled by the 7th generation of the founding family, 165 years after its establishment. Nowadays the family comprises at least 300 individuals and the various family branches are represented by different ownership vehicles. A critical mass still votes in concert such that the company is a controlled one and, through conversations with family members, we know they remain determined that the company remains in family hands for many generations to come. To encourage a little long-termism in others, minority shareholders are rewarded with enhanced dividends and voting rights once they have spent a few years on the shareholder register.
Another example of a company enduring through many generations is a German group engaged in life sciences, healthcare and electronics. It derives a sizeable portion of its revenues from emerging markets. The company celebrated its 350th anniversary in 2018 and is controlled by 12th generation descendants of the company’s founder. The company is structured as a KGaA (Kommanditgesellschaft auf Aktien) under German law, a structure that enables companies to establish themselves as corporations with general partners. General partners – covering both family members and members of the executive board - accept unlimited personal liability for the company’s obligations. For the individuals covered, this is a potentially devastating departure from the design of most joint stock companies that ensure limited personal liability. The German company’s prudent and measured risk-taking is unlikely to be a coincidence. Such corporate structures are rare, but similarities are found in Indonesia where directors of banks must also accept personal liability. This rule was brought into force in the wake of the Asian Financial Crisis in 1997. Indonesia’s banking sector is very well capitalised; possibly too well capitalised in the case of some banks, if such an accusation can ever be made within such a leveraged sector. It does beg a question though: how would the Global Financial Crisis of 2008 have unravelled, if at all, if unlimited personal liability had applied to directors of banks the world over? How different would the world look now?
A small handful of companies in which we invest are ultimately controlled by foundations or philanthropic trusts. The result can be unusually long time horizons with profound cultural implications that are palpable when speaking with company representatives. An Indian multinational conglomerate of companies is controlled by a holding company, which itself is controlled by a number of highly-effective philanthropic trusts that date back to the late 19th century. Funded by dividends, these trusts distribute roughly $150m per annum to a range of charitable causes.3 Playing such an important role in society, it is no surprise that the multinational conglomerate is well known for its responsible treatment of many stakeholders and its long-term business practices. A sturdy anchor to invest alongside.
A particularly elegant example of a business-person creating a patient ownership structure benefitting society at large is found at a Brazilian financial institution. Its founder had the foresight to establish two vehicles in particular that ensured the bank would be managed responsibly long after he was gone. First, he left a sizeable portion of the bank’s common shares to a vehicle in which the managers of the bank (300 or so today) would be required to use half of their remuneration to purchase shares. They would only be able to sell these upon retirement, and even then would only receive the proceeds over a number of years. This is one of the most unusual and well-designed remuneration structures we have encountered. Second, he established an educational foundation which itself owns a sizeable portion of the bank. The foundation has an annual budget today of well over $100m, funded by dividends. These foundations were schooling over 90,000 children free of charge last year and they are governed by the same individuals that govern the financial institution itself. One can imagine the degree of patience and purpose with which these individuals manage the bank. Their motivations cannot be measured in reais, and certainly not in reais to be received as a bonus next quarter.
A more frequently encountered ownership structure is where the local owner of a business seeks to align his or her interests with that of its business partners through common ownership. For example, a Chilean family owns over 80% of their holding company, which was founded in 1957 and today holds stakes in various businesses that are controlled and operated in partnerships. This includes the country’s largest brewer which is controlled in partnership with the world’s second largest brewer (itself a family-controlled business). They also control Chile’s largest bank, in partnership with USA’s third largest banking institution. Turkey’s largest holding group is another example. The founding family continues to own 70% of its holding company despite the many severe economic storms that have challenged the country since the group’s establishment in 1926. Some of their subsidiaries are fine examples of the power of partnership. One of the family’s companies manufactures commercial vehicles for sale primarily in Europe in a subsidiary they control along with one of the world’s largest car brands; they manufacture passenger vehicles in another subsidiary with another leading car brand. We take great comfort in business arrangements between partners that endure for decades - such continuity offers important clues as to a business group’s commitment to equitable business practices over many years.
Only rarely do companies without an anchor demonstrate the sobriety and long-termism we believe so essential to durable success. We do, however, own a number of free float companies without the enduring anchor of a controlling shareholder. In such cases we always look for evidence of equivalent mindsets in the individuals we meet and the cultures found at their companies. The flip side of the coin is that there are a vast number of controlled companies whose corporate governance standards are poor. It is often said that family-owned companies provide both the best and the worst examples of corporate governance. One corporate structure in which we have never invested, and will continue to find challenging in most if not all circumstances, is that of the Variable Interest Entities (VIEs) through which foreigners must ‘invest’ in certain Chinese companies. The word ‘invest’ appears between inverted commas because it is explicitly illegal for a foreigner to own shares in the companies that the VIEs contract with. The VIE is a legally engineered workaround that is only about twenty years old. That does not strike us as a very long period of time to test the resiliency of a structure designed to circumvent the dictates of an authoritarian regime.
The above list is intended to give some examples of the elegance with which some companies are structured to encourage long-termism and responsible business practices. As finance textbooks point out, there is always a Principal-Agent Problem to consider when shareholders entrust distant management teams with capital. We address the problem by searching for solid anchors; by investing in companies that are patient by design.
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