Recent changes to accounting standards may allow investors to look beyond 'the numbers' and more easily assess corporate stewardship and the efficient use of resources, says Nick Anderson
As a manager of sustainable investment funds, I believe that how companies navigate the challenges in a world facing significant structural change is very important.
Material environmental and social developments present both risks and opportunities across the corporate sector.
Recent evidence from the US suggests management teams that are more attuned to long-term environmental and social developments are also judicious in their allocation of capital: they are simply good managers.
There are plenty of ways to judge executives, but history is always a fine place to start. Even when investors choose to focus on environmental, social and governance issues, the financial performance of a company remains an important consideration.
The Henderson sustainable and responsible investment (SRI) funds focus on companies that can grow sustainably – in all respects. This includes the sustainability of cash flows and the appropriate allocation of capital.
Not just a number
Companies formally report their financial performance to shareholders in their report and accounts. Many of us think of accounting as being all about the numbers, the reporting of revenues and profits, assets and liabilities, together with the detailed notes and assumptions that support the headline figures.
In a slightly dismissive manner, we sometimes refer to accountants as 'bean counters'. But at the heart of the discussion about the future of accounts, and financial reporting more generally, is a debate around concepts and words, which runs much deeper than the numbers.
The accounts for most quoted companies outside the US are based on standards set by the International Accounting Standards Board (IASB). At the very top of the IASB's hierarchy is its conceptual framework. This sets the overriding principles upon which all other accounting standards are based.
Management teams that are more attuned to long-term environmental and social developments are also judicious in their allocation of capital: they are simply good managers.
Heated debate surrounds the future of the conceptual framework. Should companies be prudent when reporting or should they produce their accounts on a neutral basis without any bias? To what extent should assets and liabilities reflect current market values or be based on historical transaction values? And, even more fundamentally, what is the purpose of financial reporting?
The debate over the primary objective of financial reporting has been a hot topic within standard-setting circles. Should this be to help investors in their buy, hold, or sell deliberations? Or should it also incorporate the principle of holding management to account as stewards of shareholders capital?
Much of this is semantics. While formally promoting stewardship to a primary objective may make us feel better, in practice it is difficult to think of any information that would help investors assess whether management have been good stewards that is not also useful in reaching buy, hold, or sell decisions.
IASB and Henderson
Investors, portfolio managers and analysts have been at the periphery of the debate when accounting standards are devised.
For those who prepare the accounts and the auditors, financial performance is much more of a focus, whereas there are many factors that can influence the long-term direction of security prices.
Towards the end of 2014, the IASB launched its 'Investors in Financial Reporting' programme, a partnership with some of the world's leading asset managers and owners designed to foster greater investor participation in standard setting.
As a founding partner in the programme, Henderson welcomes the initiative and is committed to working with the IASB to develop a richer dialogue between standard setters and the users of financial reports.
It is difficult to think of any information that would help investors assess whether management have been good stewards that is not also useful in reaching buy, hold, or sell decisions.
In our rapidly changing world there are many important factors for investor to consider, both traditional financial metrics and also social and environmental issues.
High quality reporting clearly has a critical role to play, through financial numbers and the accompanying narratives, to help investors better understand the performance and prospects of companies.
We live in a world of scarce resources: better corporate reporting should help ensure that they are allocated in an efficient and sustainable manner.
Nick Anderson is investment manager for the Henderson Global sustainable and responsible investment funds
