Performance summary
The Australian strategy earned a return of 1.9% in the December quarter, around 1 percentage point higher than the benchmark return. In the calendar year 2019, the strategy produced a return of 39.7%, well above the benchmark (24.0%). The largest three holdings are Fortescue Metals, Evolution Mining and Magellan Group, while the largest sector exposures remain non-bank financials, resources and REITs.
In Australia dollar terms, the global strategy produced a return of 14.9% in the December quarter, around 2 percentage points higher than the global benchmark, while the strategy produced a return of 34.2% in the calendar year, well above the benchmark return of 27.9%. The largest three holdings are Saputo, Frasers Group (formerly Sports Direct International) and Apollo Global Management. The largest sector exposures include software & computer services, general retailers and healthcare & biotech.
Since inception in September 2018, both strategies are tracking above their respective benchmarks.
The modern entrepreneurial corporation in Australia
The modern entrepreneurial corporation is a hybrid that lies between two organisational types, the open corporation, where there is a complete separation of the ownership and control of corporate assets, and the closed corporation or private enterprise, where the decision management and risk bearing functions are combined in the owner/manager. The modern entrepreneurial corporation has two defining characteristics: the active involvement of the company founder as a senior executive and/or board director with a material ownership stake and a diffuse shareholder base.
Agency theory represents the foundation of conventional corporate governance mechanisms. Developments such as board independence and incentive pay are designed to align the interests of the CEO with those of the firm’s risk bearers. Yet it is not clear that the one size fits all approach to corporate governance is appropriate for founder companies because senior management is not completely separate from ownership.
We have compiled evidence on ASX listed founder companies in Australia over the past five years, which challenges the conventional view that these firms are poorly managed. There are over 100 founder companies listed in the All Ordinaries, most of which fit into the small-cap or micro-cap categories. They are prevalent across most sectors although they are heavily represented in technology sectors that are human capital intensive with a high level of complexity. These types of companies probably require strong leadership combined with a high level of technical capability and innovation, skills that a successful founder can bring to bear as a CEO and/or director.
The operating performance of Australian founder companies over the past five years has been superior to non-founder companies; they exhibit significantly higher return on assets, return on equity and asset turnover. These results are not driven by industry, size or risk effects. Importantly, founder companies do not appear to take on excessive risk in order to achieve stronger profitability. Their leverage ratios are similar to non-founder companies, while capital intensity is significantly lower and they maintain higher cash to assets ratios. The higher cash balances do not seem to reflect a desire to build up internal resources to fund empire building projects. On the contrary, founder companies have significantly higher dividend payout rates.
It is puzzling that firms with higher profitability and stronger growth prospects - reflected in their price to book premiums - also pay shareholders higher dividends. We speculate that founders’ ownership stakes achieve a strong alignment of interests. But above and beyond this, we also believe that company founders have steward-like qualities, including having a deep psychological attachment to their firm. These factors might help to explain why small boards and low board independence that are characteristics of modern entrepreneurial corporation have not been an impediment to their strong operating performance.