Are Politics and Proxy Firms Killing Your Investment Returns?

 | Jan 22, 2018 | 2:00 PM EST
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There are many factors that go into making a prudent investment decision.

Industry analysis, including how a group performs based on where the economy is in the business cycle.

Company-specific analysis that should include a standard strengths, weaknesses, opportunities and threats, or SWOT, analysis.

Understanding the levers to a company's financial performance. Where does it really make its money, and what are the factors that goose or weigh on profits and earnings-per- share generation? What are the capital needs of the firm?

What is the Federal Reserve doing about monetary policy? How does that impact a company and what does it mean for its balance sheet and interest expense if it has any?

Those are just some of the questions one needs to ponder as part of a rational and prudent investment decision process, and candidly, this is just scratching the surface depending on the industry being looked at.

There are also a multitude of dangers when it comes to investing, such as not objectively listening to the data; superimposing your view on the data so it magically "says" what you want it to; becoming overly attached or emotional with your investments; and letting one's politics or ideologies, or worse yet, those of others, get the better of you and influencing your investment decision process.

Odds are you know about many of these hazards, but it's the last one that is cropping up more and more given the increasing political divide. In the recently published "Politics Over Performance Volume 2: New York City Pension Funds" we found the following:

"Instead of focusing on sound fiscal practices that ensure pensioners get the retirement benefits and security they were promised without harming taxpayers or bankrupting municipalities, those who manage many public pension plans have used beneficiaries' assets to advance social or political agendas. These funds have become a leading force in corporate shareholder activism, seeking to sway boardroom decisions on social and environmental policy, and doing so in many cases at the expense of those they are supposed to be serving.

On January 10, 2018, city officials announced that the five pension funds will be taking steps to divest from fossil fuels -- another alarming example of prioritizing politics over performance, as economic reports find such a decision could cost billions."

It comes as little surprise then that a recent perception survey released by the consulting firm Spectrem Group found that "an overwhelming majority of pension fund members care about their pension fund's performance above all else, and believe fund managers should focus on returns." Odds are the individual that is socking part of their pay check away in a pension fund feels the same way, thinking "Focus on the returns, so I have the maximum amount of money possible when I retire."

As much as we might like to think the above study on NYC is just one case, it's not. There are a number of other examples that have left returns on the table because investors let their politics or social concerns get the better of them. Call me cold blooded, but over the last five years, shares of tobacco company Altria (MO)  have soared more than 100%, and that's before factoring in its stream of steadily rising dividends, compared to an 86% increase in the S&P 500 over the same time frame.

And that's just one name and one time frame. According to a report from Wilshire Associates, "Those investors who continued to invest in tobacco have, in fact, seen over 900 percent in cumulative returns over the past 15 years, making the tobacco industry the second-highest performing industry over that time period and significantly outperforming the broad market."

Outside of tobacco land, a recent report from the American Council for Capital Formation (ACCF) called out the California Public Employees Retirement System (CalPERS) board members for overemphasizing Environmental, Social and Governance (ESG) investments that have underperformed the market averages and other investment strategies and weighed on fund investment returns.

We're also seeing corporate management teams come under scrutiny from proxy advisor firms. Case in point, last summer the board of pharmaceutical company Mylan NV (MYL)  was placed under a microscope as proxy advisor Institutional Shareholder Services (ISS) urged shareholders to oust them. The charge by ISS was the board failed to prevent a "significant destruction in shareholder value" following the EpiPen pricing controversy.

Proxy firms such as ISS give advice to large institutional investors and the data suggests they can influence the outcome of a shareholder vote by as much as 20%. Interestingly enough, however, a study conducted by the Stanford University Graduate School of Business found there is little evidence that proxy advisory recommendations are correct or that they improve corporate outcomes. Rather, the study found proxy firms might actually decrease shareholder value.

Over the last six months, Mylan shares have climbed 22% -- beating the 13.7% price move in the S&P 500 over the same period.

The moral of the story is investors should stick to the fundamentals when assessing an investment decision -- and the same can be said for fund managers pension fund managers as they keep their fiduciary role in mind. That's exactly what Mylan management did when it rebuffed a takeover offer from Teva Pharmaceutical  (TEVA) , a company that has its own share of troubles in the form of declining generic drug prices and patent expirations that led it to shed 14,000 jobs, roughly one-fourth of Teva's global workforce.

We're wondering if any proxy firms are planning on issuing high marks to Mylan for making the right decision.

Putting that piece of snark aside, we'll continue to focus on and listen to our three- pronged investment strategy.

This commentary was originally sent to subscribers of Trifecta Stocks on Jan. 22. Click here to learn more about this portfolio, trading ideas and market commentary product.

-- Bob Lang and Chris Versace are co-portfolio managers of Trifecta Stocks.

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