Brunswick Review Issue 1

Anthony Bolton - President, Investment, Fidelity International

When executives start clamming up and start giving less information than they did previously, says the President, Investment, Fidelity International, that’s the time to get worried.

We use a variety of techniques to analyze the businesses we invest in at Fidelity – but one to which I have always attached great importance is the company meeting. A company meeting is a regular update that always takes place at our request, typically happens every six months or so, and involves a dialogue between our investment managers and analysts and the senior management team of the company.

The success of our approach depends – in good times and, perhaps especially, in bad – on the openness of this dialogue. If companies are not able to answer every question they should be honest and say so. They may have a high caliber management team but if they are not straight with us in meetings we are unlikely to make, or retain, an investment.

Over the last six to nine months, certain banks have tried to maintain investor confidence by putting out a positive message about their capital requirements and their underlying financial health. These subsequently turned out to be wrong, or even misleading, and people have frankly felt let down. When companies lose the confidence of their investors they can find it very difficult to regain it.

I am certainly not saying that executives should admit to having no clue, however uncertain the future. The current economic crisis might be one of the worst any of us has seen but no one can say it was unexpected. I have experienced a few downturns which did creep up quietly – you only realized you were in them once it was too late – but this is the most clearly heralded I have known.

That means companies should have contingency plans in place. They may not know where things are going, but as an investor you want to know what they will do under a range of different outcomes – and their fall back position if things get really bad. You want to be sure that they have thought about this in advance and that they are prepared. Companies in the current circumstances should not be thinking about handing down forecasts to the market place cast in stone; they should think of themselves as a group of people seeking to demonstrate that they can manage their businesses well in fluid and challenging times.

Should companies communicate more or less in the current environment? It may be a bit ambitious for us to expect more communication, but they should certainly not do any less. They should resist the temptation to become too inward looking, or to think that they can afford to cut down on investor meetings or external communications because they have nothing useful to say. When executives start clamming up and giving less information than they did previously, I begin to worry. I have seen people withdraw into their shells because they have been too positive in the past, or because things have not worked out in the way they expected and they think they have lost credibility as a result.

I respect management that comes to us and explains that, while six months ago the information they had at their fingertips justified a particular message, in the meantime things have changed. I was struck by some of the big mining companies’ robust forecasts six to nine months ago, but they have been open about what has happened since and I do not think it would be reasonable to have expected them to anticipate the speed with which market conditions changed or the severity of the downturn. By contrast, I do believe that some companies in the financial services sector should have understood their real circumstances more clearly.

Our meetings with companies are not the only way we come to a decision on whether to invest – but they are a key part of the process of building conviction about stocks. At the moment, balance sheet strength and banking covenants would be top of my list of topics for discussion as the risks for anyone in a weak financial position are obviously elevated. However, we are always interested in this sort of thing and the broad discussions taking in everything from the new product pipeline to new executive hires are similar at all times.

One thing I do not usually do is look to the management of companies to call the bottom of the market. Individual companies tend to be quite focused on their industry and if you are, say, a medium sized car parts manufacturer you are probably not going to see the bigger picture. Investment managers like us – with a wide network of contacts, market commentators and industry-specific experts – can be in a better position to call the turning points.

I think it is also true to say that the very strong culture of shareholder value that has built up over the last 20 years means that businesses want both to be successful and also to be perceived as successful. Their natural bias, let us say, is not to be over pessimistic. That is why we always set the agenda in company meetings: the presentation they have prepared will naturally play up the good bits and play down the bad. It is our job to try to establish a balanced view.

Looking ahead to the next 12 months, I think the governance agenda will be increasingly important. In a bull market, when things are going well, it is relatively easy to identify a poorly performing company in a sector where everyone else is prospering: it is not hard to suggest that management may not be up to the task and that changes should be looked at. In a contracting economy, where all companies are suffering, it is less clear when bad management is to blame.

Inevitably, with share prices down and options out of the money, incentives have become a controversial area. We are certainly looking at all our approaches to remuneration. We are normally pretty strongly opposed to the re-pricing of options but I do think one has to guard against knee jerk reactions which may lead to a situation where the only way to get decent incentives is to change the management. There is no question that in many cases remuneration policy has been focused too much on the short-term and I think we’re likely to see both a longer performance vesting period (during which executives will have to wait for the award of shares) and a further mandatory period of time when managers will have to hold on to incentive stock. Personally I am not in favor of claw backs (the proposal that would see executives handing back their rewards retrospectively if they were perceived to have failed). Imposing too many conditions risks stifling innovation and personal motivation because people start seeing the rewards as academic and something they are never going to be able to get their hands on.

There is a minority view in the European Union – but a meaningful one – that everyone should go back to fixed salaries and variable pay should be minimal. I totally disagree with that as a shareholder because appropriate motivation is an important way of getting the outcomes we all want. I have no problem with a high variable remuneration structure provided that it is symmetrical – in that if success is well-rewarded, failure should not be. Companies are going to have to think carefully about how to communicate this issue, just as they are about everything else.

Anthony Bolton is President, Investment, at Fidelity International. His Fidelity Special Situations fund has been the top performer in its sector since its launch in 1979. He was manager of the fund for more than 27 years and now has a full-time role mentoring Fidelity’s younger fund managers and overseeing Fidelity’s investment process.