Mind the Gap - Majedie

Mind the Gap

The policy response to Covid-19 could help society bounce back on a more equal footing, writes Emily Barnard, and Responsible Capitalism has an important role to play.

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This article featured in our Summer Journal.

Inequality in its myriad forms was rising up the social agenda long before Covid-19 struck. The pandemic has since brought many of its worst effects into sharp relief, exposing longstanding fissures when it comes to wealth, income, gender, race, health, education, as well as the allocation of environmental resources. Minority racial groups have suffered markedly worse health outcomes, for example, while remote working has favoured those with white-collar jobs and better access to technology.

At the peak of the lockdown, roughly a quarter of UK workers were furloughed and paid by the state – astonishing given the government is headed by a Conservative leader who defeated a big-government socialist in a general election less than a year ago. In the aftermath of the pandemic, we could see greater spending on the National Health Service (NHS), Prime Minister Boris Johnson and Chancellor Rishi Sunak following through on their commitment to ‘level up’ the regions, national infrastructure spending in areas like 5G to help tackle technological inequality, and spending on a faster transition towards renewable and low-carbon energy to create more affordable access for wider society. In short, Covid-19 may yet be the spark that moves inequality from the social agenda to the political one. The co-ordinated fiscal and monetary policy response to this crisis provides a real opportunity to help the economy emerge in a fairer way.

Indeed, a sense of equity and shared responsibility has run in parallel with the policy framework. The UK government’s funding of businesses (for which the taxpayer is the ultimate backstop) has come with political and regulatory pressure on dividends and share buybacks, for example. This was laid bare in a letter from the Bank of England’s Prudential Regulation Authority which nudged banks to consider ‘suspending dividends and buybacks on ordinary shares until the end of 2020. Should your board take such a decision the PRA would publicly welcome it.’[1]. The PRA also gave advice about how senior staff should be rewarded during the pandemic: ‘The PRA also expects banks not to pay any cash bonuses to senior staff, including all material risk takers, and is confident that bank boards are already considering and will take any appropriate further actions with regard to the accrual, payment and vesting of variable remuneration over coming months.’[2].

Clearly the PRA’s intention is to patch up any leaks where funds could simply transfer from the government coffers to shareholders, therefore diluting the potential impact of these policies. In a similar vein, the UK government’s flagship support scheme for large businesses, the COVID-19 Corporate Financing Facility (CCFF), recently brought in changes whereby businesses will need to commit to showing restraint on both dividends and senior pay, where there are outstanding borrowings under the CCFF facility that mature later than May 2021. The implications of these policy conditions are clear – if you want government support there is a social contract to abide by. This nod to wealth and income equality was less apparent in the policy responses to the global financial crisis in 2008.

Firms are also recognising the pressure to act responsibly and share the load when it comes to the policy response. In fact, some have promised to reimburse the government for furlough support after the business environment turned out to be less challenging than originally expected, The Spectator being just one example. We have also seen cases where firms are proudly proclaiming that they have not needed taxpayer funding during this period. For example, a holding from our small-cap portfolio has said: ‘Whilst we have met the criteria to make a claim under the UK Government’s Coronavirus Job Retention Scheme, we have decided not to make a claim on the grounds that that scheme was designed to protect jobs rather than to boost profits for companies who have been able to continue to trade.’

Responsible Capitalism has an important role to play
Given the unique challenges posed by the virus, the road to economic recovery could be long and bumpy. Nevertheless, with inequality rising up the agenda and social issues coming to the fore, it is vital that we consider how both society and the investment environment could foreseeably change over the medium term, integrating our analysis into discussions with companies to understand the measures they have in place to best navigate and manage their risks and opportunities. Macroeconomic ESG analysis such as this has a direct bearing on the conviction we have in the companies in which we invest on your behalf.

There are several salient qualities we look for in a firm that signal to us that it is aligning its interests with key stakeholders. First, we like to see that companies have widespread equity ownership throughout the management team, and within the wider business, if possible. Speaking from our own experience at Majedie, where every employee owns shares in the business, we know that equity ownership incentivises staff to behave in the best long-term interests of the business and its clients. Employee ownership in a business can also lead to a higher staff retention rate, where knowledge and skills are kept within the business. And, as inequality is more closely examined post Covid-19, companies with greater levels of equity ownership by employees could be viewed by investors as having more appropriate levels of shared pain, as well as shared gain. Going forwards, it could be these companies that are better placed to win the favour of investors who are making asset allocation decisions.

Secondly, we believe it is crucial that companies take real ownership of the pain being felt by their employees due to the pandemic. Those companies which are better at managing the risk of losing well-trained workers are frequently choosing to have their directors and executives take pay cuts, in some instances enabling furloughed employees on 80% of their salaries to be topped up to 100%. Our process is to look holistically at our investee companies and assess how each is managing its key risks and opportunities. For us, this is not a box-ticking exercise. It is an evidence-based approach, analysing how companies react to and behave during a crisis and how they manage the critical issues that heavily impact their business.

Thirdly, we take into account how companies are behaving when considering their requests for raising capital to help fund their balance sheets. Certainly, a number of companies have undertaken corporate recapitalisations since lockdown began. We take a holistic view when thinking about companies’ requests for fresh capital and ESG considerations form an important part of our due diligence. Understanding the whole picture, in these instances, helps us make better decisions about participating in capital raising. For example, we ask companies if the executives are participating, themselves, in the equity raise; if staff are being furloughed; if the executives are taking a pay cut to enable top-ups to employee salaries; what measures, if any, companies are taking to ensure the health and safety of colleagues; if companies are working with stakeholders, such as their landlords, to pay incrementally lower rents, rather than simply not paying rent at all; and finally, how they are treating their supply chains.

To put this into context, one capital raise we supported in the UK Smaller Companies portfolio was for an existing position, MJ Gleeson. MJ Gleeson builds low-cost homes targeting first-time buyers. It was raising capital to secure its supply chain, accelerate the restart of build sites, and complete builds on its forward order book – giving priority to key workers. This capital raise appealed to us for a number of reasons. First, government policy is likely to be particularly favourable to first-time buyers and key workers coming out of this crisis, and so the company was moving early to position itself to capture this future growth. Secondly, MJ Gleeson is a small housebuilder and, in an environment with lots of businesses restarting at similar times, it makes strong economic sense for it to secure its supply chain in advance. Finally, management demonstrated good faith by taking a significant pay cut alongside their furloughed employees, and by putting their own money, alongside investors, into the capital raise.

We are confident that this time around – in 2020 on the back of a pandemic – the injection of capital into the economy could have much more positive effects than quantitative easing had in 2008. But spending needs to be focused in the right areas not only to help the economy, but to support society and the planet, as well.

Going forward, Covid-19 is likely to place increasing importance on companies’ consideration of how they treat employees and impact wider society. We are looking to identify those companies that are likely to come out stronger on the other side: more proficient, with a greater focus on people, planet, and all stakeholders. These are the companies we are committed to investing in, as we believe they offer the best risk-adjusted returns for our clients.

(1) https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/letter/2020/letter-to-rbs.pdf?la=en&hash=A1A04A976B5118D7CAAA1435338C2C33AE242BA7
(2) https://www.bankofengland.co.uk/prudential-regulation/publication/2020/pra-statement-on-deposit-takers-approach-to-dividend-payments-share-buybacks-and-cash-bonuses