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Tainted by scandal: how to approach crisis-hit investments

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Tainted by scandal: how to approach crisis-hit investments

Set-back, scandal or crisis, whatever you want to call it when something goes wrong with a company, investors are forced to make a decision: do they pull out or wait for recovery?

Several recent issues have focused attention on why investors need to take corruption seriously.

Earlier this month two HBOS bankers, Lynden Scourfield and Mark Dobson, were sentenced to 11 and 4.5 years in prison respectively for bribery and fraud. HBOS merged with Lloyds in the 2008 financial crisis, and ended up writing off £245 million from Scourfield’s loan book.

‘It’s time investors began taking seriously the risk of scandals – and started to price it in,’ said Rita Trehan, an independent business consultant and expert on company turnaround strategy.

‘While the scandal hasn’t moved Lloyds’ share price, it is only the latest in a string of global scandals that have rocked the corporate world, including at Samsung and VW.

‘[These] have left many investors with massive, and likely irrecoverable, losses. While it is not possible to avoid these risks entirely, it is sensible to at least think about them. And this is something few investors are doing right now.’

At the end of January, accounting problems at BT’s Italian division were exposed as far worse than had been previously identified, sending shares in the telecoms company down 20% to a current figure of 308p, 35% lower than a year ago.

‘It is interesting how people react to issues like this,’ said Richard Marwood, manager of the Royal London UK Growth fund, following BT’s disclosure.

‘I always think shares are slightly unusual instruments, in that classic economic theory tells you that the price of something goes down, consumers get more interested but it’s the opposite in the stock market.’

Although Marwood admits there were several issues within BT, namely its relationship with regulator Ofcom and how onerous pension liabilities are going to be, he says the company’s troubles do not change its fundamental story.

‘It is a shock and disappointment but the underlying strength of the business is unchanged. I think the equity market tends to overreact both from the upside and the downside. Quite often we find when shares have had shocks like this there is a lot of jumping up and down wanting to change management. I don’t think that’s necessary.’

Marwood believes that falling prices often provide opportunity to buy at attractive valuations. However, he warns that investors have to make their own subjective judgement on the ongoing feasibility of a business, and if the news fundamentally changes that.

He highlights Pearson and Capita as examples of firms that have had issues and seen price falls, but after analysing business fundamentals Marwood decided he was not comfortable with buying in due to structural problems.

For Ken Odeluga, market analyst at City Index, the sell-off of BT shares suggests that ‘even the least activist institutions have lost confidence in governance and competence’. He added that a broad review of management strength may be required to draw a line under the issue.

‘There’s no evidence that chief executive Gavin Patterson had any inkling before last autumn of the malfeasance abroad,’ he added. ‘Although he has been in charge since 2013, and before that was BT’s retail boss for five years, apparently stringent scrutiny turned up nothing for years. But there lies the rub. Culpability is lacking, but failure to spot the issue still puts Patterson in the frame in the eyes of many shareholders.’

Another company that has been rocked by scandal in recent years is Volkswagen. The emissions debacle that erupted in September 2015 wiped around one third off its value at the time, with investors split over whether to sell or hold.

Investors slapped the car manufacturer with damage claims totalling €8.2 billion last year, and a series of class action lawsuits are currently working their way through the courts.

In light of VW’s troubles, Trehan asks: ‘Would it have been possible to predict the VW scandal? Of course not. But how many investors even considered the potential for scandal, and looked at its corporate culture before committing it to their portfolio? My guess is very few.’

She highlighted two primary ways an investor can mitigate risk: ‘Alongside doing due diligence on a potential investment’s finances, business plans and growth figures, they should conduct a similar exercise on its corporate and workplace culture.

‘There are often signals that a company is at risk of scandal: an unaccountable CEO, a religious and unhealthy focus on short-term results, and bad workplace morale.’

Secondly, she recommends investors should demand that companies take workplace culture more seriously, including accountability at board level.

Similar to BT and VW, Marwood highlights News Corp as a one-time source of investor jitters. ‘There was lots of negative sentiment but ultimately there was a corporate out on that one. If you think there is a fundamentally attractive business you will get rewards,’ he said.

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