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Observations from the proxy voting season

by Michael Herskovich

While executive pay was a key issue for many shareholders in 2009, this year they paid closer attention to the work of the board of directors and its composition, as well as to how their interests are represented.

The financial crisis has revealed the important role of the board of directors in determining corporate strategy, overseeing its implementation by senior management and monitoring risks. It has also shown how important it is to have independent and qualified directors.

CapitalCom's fifth annual study reveals that three quarters of individual shareholders feel that the board of directors does not fulfil its role. In some countries, such as France, the chairman/CEO is making a comeback, reuniting the separate roles of chairman of the board and chief executive officer.

To limit this concentration of power, some companies have appointed a lead independent director responsible for overseeing good governance and relations with minority and institutional shareholders. Although a step in the right direction, this is no substitute for a clear separation of roles and a truly independent board of directors capable of overseeing senior management effectively to prevent the abuse of power or conflict of interests. Over and above the issue of independence, directors’ qualifications and diversity were also subjects of much debate at annual shareholder meetings this year.

Now that the European Union member states are completing the transposition of the 2007 Shareholder Rights Directive, concrete measures are being implemented, such as establishing the record date system and preventing share-blocking. The transposition should ensure that shareholders are better informed about meetings and can exercise their voting rights more effectively.

There has also been progress in the field of remuneration practices. More and more companies in Germany, Switzerland and the United States are allowing their shareholders to express their opinion via "say-on-pay" resolutions. Shareholders will be careful to ensure that remuneration is aligned with financial results and based on real and explicit performance criteria.

Environmental and social issues are arising more frequently in the United States, and more than 300 shareholder resolutions have been submitted in the first quarter of 2010. A significant proportion of these resolutions were about climate change (oil shale mining in Canada, for example) or about companies’ and their suppliers’ respect for human rights. We are also seeing a significant increase in shareholder resolutions to abolish anti-takeover defences.

Conversely, there is a resurgence of takeover deterrents in Japan, with more cross-shareholdings and the development of ’poison pills‘. The same is happening in South Korea, where a new law will probably enable anti-takeover defences similar to those allowed under a French law adopted in 2006.

We are emphasizing the following principles through our voting policy:

• Having a majority of independent directors, so that the board can assert its oversight over management and protect the rights of minority shareholders
• Ensuring that remuneration practices are aligned with the company’s long-term interests and those of its shareholders
• Preventing excessive measures to protect share capital
• Making sure corporate strategy, disclosure and risk control take environmental, sustainable development and social issues into account

Microfinance weathers the financial storm

by Alvaro Ruiz-Navajas

Much has been said about the resilience of the microfinance sector during the crisis on account of well known companies like Mexico’s Banco Compartamos, whose share price gained 170% in 2009. However, the environment in which microfinance institutions (MFIs) operated during the financial crisis was among the most challenging ever faced by the industry. In early 2009, loans past due over 30 days reached a median of 4.7%, up from 2.2% at the end of 2008 and profitability dropped dramatically.

However, a closer examination shows that these effects were not as extreme as it may appear. First, most of this decline in asset quality took place in the first half of the year. It is interesting to note that most of it was short-term delinquency, with only a minority of loans in need of rescheduling. Rescheduling loans is a very important tool for microfinance institutions, as they have been known to use it without undermining the repayment incentive for their borrowers. 

Also, these effects have not been uniform. Countries like Bolivia and India stood their ground firmly, while others, like Nicaragua and Morocco, experienced severe delinquencies, which were not necessarily caused by the crisis. These differences can be explained by the fact that countries like Bolivia and India have much more competitive markets that have led to faster product innovation and client screening methodologies. 

So, while the microfinance industry experienced a tumultuous year in 2009, it came out relatively unscathed, and its drive to keep on improving the quality of its assets gives us an upbeat outlook on the sector.

India’s spiralling food prices

By Dirk Seel

The recent high volatility in the price of rice, fuelled by fears of severe supply shortages, has further strengthened our belief that the world is currently merely taking a break from the food crisis that started in late 2007. The structural imbalances, exacerbated by increased incomes in emerging markets, rising production of subsidized biofuels, and climate change-induced weather anomalies, have not gone away. Currently, the dramatic consequences of spiralling food prices are particularly visible in India.

Historically, the country has been self sufficient in major crops such as rice, wheat, corn, millet and pulses. However, this obscures the fact that after decades of financial neglect, India’s agricultural sector is stagnating, while its people’s income and appetite are growing. As a result, local prices for lentils, meat, dairy products, vegetables and fruit – in short, prices for all nutritious foods – have sharply increased. The ones who suffer most from this are low-income urban and rural households who no longer can afford their usual consumption patterns. What is more, global prices are affected, too. Most notably, sugar prices continue to trade near 29-year highs, not least due to the negative impact of drought on India’s sugar production. The latter aspect illustrates another alarming signal: although cropland constitutes two-thirds of its land area and half of its labour force is employed in agriculture, India depends more and more on importing goods to balance its own production shortfalls.

The country’s failed agricultural policies have caused hunger, food insecurity and malnutrition. In order to ensure that staple foods are available to the poor and to avoid social unrest, the Indian government will have to declare food security the top priority on its political agenda. Significant investments into the infrastructure of farmland must be undertaken. For example, small-scale irrigation projects are a feasible and sustainable means by which to raise farmers’ productivity while reducing their dependence on monsoon rainfall. Likewise, grain supply is in need of reform. The country’s existing public distribution system is not capable of reaching the specific needs of its various working classes. Last but not least, the country needs to address the detrimental influence of lobbying interests. Only then will there be a chance for food price inflation to stop.

Energy efficient LED solutions off the blocks

By Martina Jung

The application of light-emitting diode (LED) technology in consumer products is increasing rapidly. In particular, the consumer electronics industry is demonstrating a very aggressive approach towards integrating the latest technological advances into new products, thereby offering customers more attractive and energy-efficient solutions.

When Samsung launched a range of energy-efficient LED TV products last April, it triggered a surge in LED chip production, and left competitors such as Philips, Sharp and LG scrambling to follow suit. The resulting mass production of LED chips and the continued development of LED technology have paved the way for other advanced LED applications.

Another attractive area is LED lighting. Although LED lighting has struggled to hold its own against significantly less costly—but less energy-efficient—conventional lighting solutions, Cree, a US-based leader in LEDs for lighting, indicated with the release of its results in January that LED lighting is gaining traction.

Furthermore, a new screen technology – organic light-emitting diodes (OLEDs) – is about to emerge. OLED screens are far more energy-efficient than current LCD screens and, what’s more, OLED screens are flexible. Last April, Japan-based Kyocera presented a flexible OLED cell phone concept, which users can fold like a wallet.

If LED technology continues to develop at the current pace, its market penetration and energy savings potential is set to outpace all prior expectations. Already, Bank of America/Merill Lynch expects the proportion of TVs with LED backlighting to rise to 32 % by 2012, from just 1 % in 2008.

Some governments have drafted energy efficiency regulations that will boost LED technologies. Under new legislation in the EU, for example, homeowners must replace inefficient incandescent bulbs with more efficient alternatives, including LED lights. And last year, China installed more than 100,000 LED lamps across ten cities in a pilot project; the next stage will be 1 million LED lamps across 20 cities.

Policy makers such as those in China and the EU, and beyond, may soon realise that the contribution of LED technologies to climate protection is accelerating far beyond their expectations. For investors, this could mean there will be growing numbers of compelling investment opportunities in the LED market.

Vaccines: The few needles left in the haystack are still worth finding

by Florian Sommer

As pharmaceutical giants stare out over their well-publicized cliffs of patent expiries, vaccine industry participants are bathing in a comparative ray of sunshine. What was once an overlooked backwater has been sought out and picked over in a conglomerate search for growth. The swine flu has further enforced this change.

Vaccines used to be relatively unattractive products, with a high amount of upfront investment required, mediocre margins and a high amount of risk involved in achieving any return. The production and manufacturing plants are heavily regulated, spates of lawsuits were always a threat from possible side effects and in the case of a serious national emergency, manufacturers were occasionally forced into giving up the intellectual rights covering their products. Given those risks in what is a relatively small, bulk-order and price-based industry, it is no surprise that the number of manufacturers has consolidated from around 26 major players in the U.S. in the late 1960’s, to around 5 today.

However, as recent pandemic threats have shown, the health of any one nation is now increasingly dependent on the health of the rest of the world. The swine flu scare in particular, has again prompted governments in trying to address a global lack of manufacturing capacity. This should continue a trend that has emerged since avian flu, whereby several of the afore-mentioned issues have been rectified through funding, as authorities had to bridge the development gap that companies were unwilling to cross. Large pharmaceutical companies have also sat up and taken notice, and have been cornering the sector through acquisitions and partnerships. Partnerships are becoming the preferred model as they allow the smaller independent firms to retain innovation and leverage off of much larger sales and marketing capabilities. The larger firms benefit from outsourcing the early-stage risk, instead focusing on their specialties of later stage trials and bringing vaccines to market. The innovation continues to breed results; vaccines are being targeted not only at high-risk infectious diseases but also increasingly as therapeutic answers to highly complex diseases such as AIDS and cancers.

The consolidation trend has been ongoing for many years now, leaving the vaccines space with few sizeable independent companies. However, as the industry continues to transform itself, those that do remain are likely to see the fruits of their research and development highly valued when negotiating commercial agreements.

Copenhagen - low expectations mean no disappointment

by Martina Jung

We had not expected a global climate treaty – or anything close to it – to emerge from the Copenhagen Climate Change Conference 2009, and we had not been optimistic that emission reduction commitments would be made, in particular by China. So, we were not especially disappointed with the content of the Copenhagen Accord.

In contrast, the wider consensus view appears to be that Copenhagen failed to meet its goal: To reach binding agreements among the participating states to tackle global warming, which would serve as the basis for a global climate treaty to be signed in 2010. Indeed, participating countries have done little more than to take note of the Copenhagen Accord, without committing to accept it. The minimal compromise achieved does not include precise emission reduction targets or control mechanisms, nor is it legally binding or unanimous.

However, there are two points in the Copenhagen Accord which give us reason for optimism. The first is the recognition among UN member states that the increase in average global surface temperatures by 2050 must be limited to 2 degrees Celsius or less. This is the first time that scientific evidence of global warming has entered political documentation, applicable to 193 states. Looking ahead, this targeted restriction will serve as a universally accepted cap against which developments can be measured. The second is the pledge by industrialised nations to provide USD 30 billion to developing countries for the next 3 years. The pledge is aimed to step up action against climate change, and may be scaled up to USD 100 billion annually by 2020. This cash should accelerate installation of renewable energy capacity.

Achievements such as these are just a first step towards a global climate treaty. For now, they will have little immediate impact on the fundamentals of renewables stocks. But the need for continuing negotiations, and the growing pressure to achieve legally binding agreements, provides room for a positive mid- and long-term effect on renewables.

In the short-term, we do expect more ambitious action on a national level. In the course of the Copenhagen conference, China and the US presented various measures that they are prepared to implement in order to reduce their carbon emissions. All of them include the increase of renewable energy capacity, implying the potential for creating new jobs and reducing their countries’ dependence on foreign resources. The statements released by the world’s two largest emitters after the conference confirm their commitment to address the climate change problem and their willingness to further promote renewable energy technologies. We believe there will be more countries that follow this path now that 193 states are involved, at least politically.

Endocrine Disruptors – Our sexless future?

By Sara Wright

Endocrine disruption (ED) has been present in scientific literature for decades, but has not coalesced into a coherent topic in the popular media. This is down to several reasons: the issue is complex, its long-term ramifications remain unclear, and the path of mitigation is not well defined.

The US EPA defines an endocrine-disrupting compound as “an exogenous agent that interferes with synthesis, secretion, transport, metabolism, binding action, or elimination of natural blood-borne hormones that are present in the body and are responsible for homeostasis, reproduction, and developmental process.” EDs are heterogeneous and include synthetic chemicals that are widely used as industrial solvents and lubricants, agricultural chemicals and pharmaceutical compounds. Not only do they have serious impacts independently, but evidence is strengthening that the combined effect of multiple EDs can be exponentially harmful to the human body and ecosystems.

Some EDs were identified long ago as being responsible for the near extinction of entire species, such as the pesticide DDT and the bald eagle population. Others are only now being identified, especially as their multiple vectors of interaction with other substances emerge. Nearly all plastics that consumers use daily contain ED compounds. The majority of people in developed countries have a shockingly high “body burden”, which indicates synthetic compound levels carried in the blood and tissues. This was not true a mere generation ago.

Even infinitesimally low levels of exposure can cause abnormalities, especially if exposure occurs during a critical developmental window. Surprisingly, low doses may sometimes exert more potent effects than higher doses. EDs can affect not only the exposed individual, but also subsequent generations. Given that some of the most prevalent EDs have emerged from industrial chemistry, a relatively new field, the effects are likely not yet to have fully manifested.

But there are alarming signs everywhere. Water animals are exhibiting bizarre deformities, often in their sexual organs. In polluted lakes, amphibians are sprouting extra legs and alligators are developing stunted genitals. In the US Potomac watershed, male smallmouth bass were recently discovered to be transforming into “intersex fish” that display female characteristics – 80% were producing eggs!

There are similar signs in the human population. A startling trend shows significant increases in the numbers of genital deformities among newborn boys. The daughters of women exposed to DES – an ED drug prescribed from the 1930s to 1970s to prevent miscarriage – seemed fine at birth, but exhibited abnormally high prevalence of misshaped sexual organs and cancer later in life. New research has also tied EDs to obesity, insulin resistance and diabetes. Examples abound, and they paint a sombre picture.

Governments are moving toward regulating these substances. If the evidence continues to grow, and frogs in a lake are our modern-day canaries in a coal mine, EDs will become as important as climate change, and perhaps even more difficult to rein in. Nearly all industries will be affected, both by legislation to reduce the use of EDs, and by litigation seeking restitution for the damage they caused. Companies that seek to mitigate effects and produce safer alternatives will benefit in the long run.

Swine flu: Longer-term perspective required by investors

By Florian Sommer

Tens of millions of people are getting ready for their vaccination against swine flu. We are in the midst of a new pandemic, as officially announced by the WHO back in June.

What does this mean for sustainable investors? First of all, pandemics have historically only occurred every 30 to 40 years. However, we have recently experienced an increasing number of epidemics that nearly reached pandemic status. Remember SARS and Avian flu.

The risk of pandemic outbreaks is increasing. In our modern world, people live closer together in urbanised centres, travel more, and eat more meat. Farmed animal populations have grown exponentially. For example, China’s poultry population has grown from 12 million in 1968 to 13 billion in 2005, while its human population only increased from 790 million to 1.3 billion. Increased proximity between animals and humans is a key risk factor, as most emerging infectious diseases originated from a species jump of a virus from animals to humans.  

What little investment research on the topic exists is dominated by a short-term focus on sectors of under- or outperformance during epidemic / pandemic events. For example, airlines were hit hard during SARS but then recovered quickly. Betting on one-off pandemic/epidemic events that are by nature quite unpredictable is not a very attractive strategy for investors. A longer-term perspective is more rewarding, such as the growing markets for disease prevention and pandemic preparation.  For example, bio-surveillance of animals is viewed as key to prevent the “species jump” from animals to humans. There are new diagnostics and testing technologies that offer more rapid and reliable disease detection. The market for molecular diagnostics has been growing between 10 and 20 percent in the last 5 years and is expected to reach USD 7 billion by 2011. Finally, governments have begun to dedicate longer-term funding to the development of more effective vaccine production infrastructure and new technologies (e.g. cell-based production methods), in order to overcome earlier problems in producing sufficient vaccines during epidemic / pandemic events.

We do not know yet how severe the swine flu will turn out to be. However, we do know that the drivers of pandemic risk are increasing and that this is fuelling a growing demand for solutions that help to prevent the emergence and spread of infectious diseases. These technologies offer attractive longer-term investment opportunities.

Sugar price hike: a reminder of what looms around the corner

By Dirk Seel

'Breakfast’ commodities currently capture headlines as their prices hit multi-decade highs. Although sugar, coffee, tea and orange juice do not qualify as vital crops, their price hike should still be seen as a warning sign of a potential food crisis repeat.

Let’s recap: driven by drought-impacted poor global harvests, growing consumer demand, rising energy costs and financial speculation, the prices of agricultural commodities dramatically increased in 2007-08, causing food riots and political instability worldwide.

Given that the prices of rice, corn, wheat and soy have fallen amid the recession to today’s relatively depressed levels, can we assume that the threat of another food crisis is history? Clearly not. Instead, the driving forces behind the current production shortfall in breakfast commodities seem to be very familiar.

Take sugar. Following a global production deficit, its price has so far risen to a 28-year high. Government authorities around the world blame poor weather conditions for the severe shortage. But there are fundamental problems too. One is regulation. Sugar is among the most heavily manipulated agricultural commodities. From import levies to production quotas and statutory minimum prices, governments worldwide use interventionist mechanisms to maintain certain price levels. The real price of this policy can be seen in India. Millers, angry about imposed higher minimum prices, made their payments late, which led farmers in 2007-08 to abandon sugar for more profitable crops such as rice. With production down 40%, the country this season switches from being a net exporter of sugar to a net importer.

A lack of arable land dedicated to cane cultivation is not the only problem. Consider the world’s ever-increasing demand for energy. Already today, about 60% of Brazilian sugar cane is used to produce ethanol, a petrol substitute. With a rising oil price, this percentage looks set to increase further. Add developing countries’ growing appetite for sweet food, and you get an idea of the heavily imbalanced supply-demand curve.

As such, the current price hike of breakfast commodities should be seen as a reminder that another food crisis is looming. After all, the fundamental drivers that contributed to last year’s crisis have not disappeared.

The dawn of E-Paper

By Alvaro Ruiz-Navajas

The nascent market for e-readers has put e-paper into the spotlight, but the potential applications for e-paper are much wider.

The technology for e-paper has been developing since the late 1960s, but its potential applications have become apparent only since the advent of the e-readers. In theory, e-paper could replace ink and paper, but given the current state of technology, e-paper is better suited to display data rather than input data. Thus, rather than being useful only in consumer electronics, e-paper could find its core markets in disposable electronics and electronic signage. E-paper could expand rapidly to a USD 3 billion market by 2015.

Disposable electronics is likely to be an area where e-paper creates a new market. Potential uses include making packaging more appealing to consumers and advertisers – as shown by the Esquire magazine cover in 2008 - the change in pre-paid cards and, most interestingly, medical instructions. Doses and instructions could be changed so that they target a specific patient, and even the time to take the next dose could be displayed.

Electronic signage is where e-paper does have an advantage over current incumbents. Currently, TFT-LCD, LED and paper dominate this segment. However, with e-paper's ability to change rapidly and its low energy consumption, it is ideal for mobile message boards in airports and train stations. For billboards, e-paper could still provide an expensive alternative to paper, but the robustness of e-paper and the possibility to update it remotely presents a compelling case. E-paper price tags that can be updated centrally have proved successful in Japan.

A frequently cited benefit of electronic paper, however, stems from its direct effect on the environment. With an estimated 4 billion trees cut down each year and most of them going to paper, e-paper could not just open new markets, but also help preserve biodiversity.