Pegasus August 2017 Edition

Transcription

1. AUGUST 2017 VOLUME VII , ISSUE VIII A NEWSLETTER FOR THE CAUX ROUND TABLE NETWORK LOOKING AT BUSINESS ABOVE THE CLUTTER AND CONFETTI VALUES-BASED PERFORMANCE High Quality Stakeholder Management & Sustainable Success Values-based Portfolio Performance Evaluations | p. 6-11
3. Pegasus Stephen B . Young 3 Introduction Magni Global Asset Management, LLC 6 Magni Catholic Values Portfolio Performance Evaluation Magni Global Asset Management, LLC 8 Magni Islamic Stewardship Portfolio Performance Evaluation Magni Global Asset Management, LLC 10 Magni Corporate Governance Portfolio Performance Evaluation Chris Bradley 12 Surprise: Those ‘Great’ Companies Generally Turn Out To Be Meh ... or Duds Erik Sande 15 Outro: The Business of Gardening
4. INTRODUCTION This issue of Pegasus could be the most important contribution yet made by the Caux Round Table for Moral Capitalism (CRT) to an understanding of responsible business conduct in free market systems using private property and the rule of law. For theologians, this is the problem of theodicy – how to vindicate God when there is evil in the world. Most of us are not theologians and so we seek reassurance at a common sense level that our behaving well will have positive practical consequences for us and those we care about. When can it be said that good things will happen to people when they are good? The principal shortcoming of such systems from a values perspective is the gap they leave between the law and what people do along with their inability to impose ethics and morals on the very actors they empower with rights to make, sell and buy. In business, seeking to answer this question is called “making the business case for ethics or corporate social responsibility.” Free systems are subordinate to human free will, which, given freedom, can turn uncooperative, harmful and even evil. Recently, the CRT developed powerful data from stock markets that makes an impressive business case for corporate social responsibility and sustainability in free market capitalism. The antidote to abuse of free will for centuries and across cultures has been the inculcation of moral norms and ethical sensibility into one’s character to be used when one is free as mechanisms of self-restraint. The new data results from application to companies of a theory of risk management and observing what happens to the stock prices of companies which manage their risks well. During the Watergate Scandal, according to his aide H.R. Haldeman, President Nixon said, “There is no problem in raising a million dollars - we can do that - but it would be wrong.” The CRT has come to assert that corporate social responsibility is a form of risk management which leads to more sustainable business success. According to financial theory, lowering risk increases the net present value of all future income to be earned by a firm and so, too, the imputed capital or overall asset value of the firm. In general, three approaches have been recommended for promoting ethical conduct: 1) rules or deontology (Kant in particular); 2) avoiding consequences or utilitarianism (Bentham and John Stuart Mill); and 3) virtue ethics or a mature socialized ego (Aristotle, Confucius, Qur’an). Next, we point out that most risk to a company lies with its stakeholders – customers, employees, access to capital (equity and debt), suppliers, its strategy vis-à-vis competitors and its community, including its regulators and the physical environment. The CRT has evolved through its many round tables more and more towards virtue ethics as a best practice for all cultures. From our point of view, virtue ethics demands a mindset which can apply principles – a form of rules – to particular circumstances which is consequentialist in its thinking. Virtue ethics seems particularly indebted to intuition and induction about first principles and right-brain discernment using the power of insight to assess reality. Thus, good management of stakeholder relationships lowers a company’s business risk. Good management of customers – selling the right products and services at the right prices and securing good brand identity and goodwill – leads to profit. But all ethical and moral advocacy for many people seems to run aground on the shoals of a hard truth: bad things still happen to good people. 3
5. Good management of employees leads to higher productivity , lower costs and more customer satisfaction. Higher Arcturus scores, then, should reveal companies which have brighter futures and so provide more attractive investment opportunities. Good management of owners and creditors leads to a lower cost of capital and immediate access to funds whenever needed. The recent data made available to the CRT provides evidence that these correlations among quality stakeholder management, risks, and share price performance are true in the real world. Good management of suppliers leads to quality products and services and to more customer satisfaction and to acceptable cost control. Next, the CRT, engaging with Catholic Social Teachings and with Qur’anic guidance, has developed customized Arcturus assessments to assess companies for alignment of their business practices with 1) Catholic Social Teachings and 2) with Qur’anic guidance. Good management of the business model lessens threats from competitors and avoids the sharp practices which permit rent extraction from customers in the short run but cause trouble in the long run. The CRT licensed its proprietary Arcturus assessment methodologies to Magni Asset Management LLC. Good management of community and regulators (think subprime mortgages, Volkswagen and BP’s Macondo well) reduces losses charged to owner’s equity and opens the scope for business innovation and expansion. Magni, then, undertook to test the capacity of the Arcturus methodology as a predictor of business success. It took as the measure of success share prices in a public market where investors buy and sell according to their estimation of the “worth” of a company. In particular, good management of stakeholder relationships enhances the intangible assets of a firm, such as its goodwill (the difference between book net assets and total market value) and its social and human capital accounts. Magni took the list of companies selected for inclusion on Standard & Poor’s (S&P) index of 500 notable firms. The market prices of all the companies on the S&P index are averaged daily according to the total market capitalization of each company and the average is published. Thus, the S&P index provides a benchmark for market pricing over time. Some years ago now, the CRT developed a proprietary methodology for assessing the quality of a company’s management of its stakeholder relationships. We call this the Arcturus Process. Questions are asked about specific behaviors of the company towards its stakeholders. The questions are designed to be answered over a continuum from bad to excellent with low numeric scores for bad performance and higher numbers assigned to better levels of performance. Other indexes can be created and compared to the S&P index to see which ranking of companies receives higher or lower prices. Magni assessed all 500 companies on the S&P index three times – once each for the secular, Catholic and Islamic standards of virtue ethics for stakeholders. From the assessments, three hypothetical stock portfolios were made, each portfolio allocating a portion of its total hypothetical investment to each company according to its rank against others in that portfolio. Higher ranked companies were allocated more money than lower scoring ones. It is important to note that conventional financial metrics – net profits, dividends, share price - are only a small part of the vectors assessed. The more people who complete the questionnaire, the more objective and material become the aggregate scores. As an interesting side point, in our experience, the higher up the hierarchy, the higher the scores. People at lower levels who are closer to reality tend to give lower scores to the company’s performance. Then, the hypothetical portfolios were sent to Morningstar Inc. for a mathematical comparison of their market returns as if they had been a real fund operating for 10 years against the actual returns of the S&P 500 over those same 10 years. The Arcturus assessment can be done inhouse and also by third parties looking at its public track record or just using their own experiences with the company. A wise company always supplements its internal survey with an external one to compare the scores to avoid self-referential illusions about its situation. The results of the three comparisons are published in this issue of Pegasus. The results are that each Arcturus values fund outperformed the S&P 500. A higher Arcturus aggregate score implies a higher quality of stakeholder management, which in turn, implies lower risk. Thus, a high aggregate Arcturus score should correlate with a higher capital or total asset value, including market goodwill for the firm. Thus, if an investor had allocated money to each fund according to its CRT Arcturus scores, he or she would have made more money than if he or she had put the same amount into a fund tracking the S&P 500 index. 4
6. The relevant measures of outperformance are : Beta: Excess Return: Beta is a statistical correlation between the up and down volatility of one investment against a reference norm. A Beta number of 1 indicates that the volatility of the investment was similar to that of the norm. In other words, the risk of the investment was the same as investing in the portfolio taken as the reference norm. Excess Return is the measure of higher returns per year earned by an investment compared to a reference norm. In the cases of the three hypothetical Magni portfolios, the Excess Returns were: In the cases of the three hypothetical Magni portfolios, the Beta correlations against the reference norm of the S&P 500 results were: -Secular portfolio: 6.56% -Islamic stewardship: 5.81% -Catholic values: 6.56% -Secular portfolio: 1.12 -Islamic stewardship: 1.09 -Catholic values: 1.12 Up Capture Ratio: The Up Capture Ratio is a measurement of how much more or less the investment earned in rising markets over the reference norm. In other words, the Magni hypothetical portfolios outperformed the benchmark S&P 500 in returns at about the same level of risk as the benchmark. High returns for the same risk provides a superior investment strategy. In the cases of the three hypothetical Magni portfolios, the Up Capture Ratios against the reference norm of the S&P 500 results were: What explains the outperformance is the convergence of the Arcturus assessment of good risk management with the ad hoc, unsystematic judgments of many investors and traders that companies they trusted for better performance. The market was not using CSR or other ethically based values criteria by which to allocate financial confidence. But their profit oriented calculations swerved to reward those companies with good risk management. -Secular portfolio: 122.90 -Islamic stewardship: 118.93 -Catholic values: 122.88 Down Capture Ratio: The Down Capture Ratio is a measurement of how much more or less the investment earned in falling markets over the reference norm. Incidentally, I was just sent a blog comment written by Chris Bradley of McKinsey & Company with an analysis of how some famous companies selected for inclusion in a small list of companies to emulate for success in capitalism did not outperform the S&P 500 by very much and some, not at all. In the cases of the three hypothetical Magni portfolios, the Down Capture Ratios against the reference norm of the S&P 500 results were: -Secular portfolio: 96 -Islamic stewardship: 95.02 -Catholic values: 95.99 In short, Bradley’s analysis shows that using the CRT values based guidelines for management of stakeholder relationships leads to out-performance over some highly touted companies at least as far as the S&P500 index is concerned. Alpha: Bradley’s analysis is included in this edition as further confirmation of the ability of moral capitalism to perform well under conditions of market competition. Thus, some good does seem to come to those companies which try to do good. Alpha is a statistical correlation between the returns of one investment against a reference norm. A high Alpha number indicates that the investment consistently outperforms the norm. An Alpha of 5 or more is attractive to investors. In the cases of the three hypothetical Magni portfolios, the Alpha correlations against the reference norm of the S&P 500 results were: Stephen B. Young Global Executive Director Caux Round Table For Moral Capitalism -Secular portfolio: 5.64% -Islamic stewardship: 4.75% -Catholic values: 5.64% 5
7. Morningstar DirectSM | Print Date: 4/13/2017 Page 1 of 1 Magni Catholic Values Back-Tested Portfolio Performance Evaluation Currency USD Benchmark 1 S&P 500 NR USD Return vs Peer Group Subject Investment Benchmark 1 Benchmark 2 32 -16 -40 History 2007 2008 2009 2010 2011 2012 2013 2014 10.79 4.90 — -33.75 -37.45 — 49.92 25.55 — 25.85 14.37 — 3.12 1.47 — 22.33 15.22 — 40.90 31.55 — 18.29 12.99 — 2015 2016-12 0.03 0.75 — 14.66 11.23 — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — Peer Group Avg Best 25th Percentile 50th Percentile 75th Percentile Worst — — — — — — — — — — Gross Expense Ratio Subject Investment Benchmark 1 Benchmark 2 706 505 304 103 Name 2009 Total # of Calculations Subject Investment Benchmark 1 Benchmark 2 120 120 0 2010 2011 % in Top Quartile 2012 % in 2nd Quartile 0.00 0.00 — 2013 % in 3rd Quartile 0.00 0.00 — 0.00 0.00 — 2014 % in Btm Quartile 0.00 0.00 — 2015 % Above B-mark 1 69.17 — — 2016 % Above B-mark 2 0.00 — — 3 2 1 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 3 2 1 2007 — 1 Month 3 Months 6 Months 1.07 3.91 8.83 1.93 3.65 7.48 — — — 1 Year 2 Years 3 Years 4 Years 5 Years 10 Years 14.66 7.09 10.70 17.58 18.52 12.81 11.23 5.86 8.18 13.60 13.92 6.26 — — — — — — Inv B-mark 1 B-mark 2 Cumulative Return Standard Deviation Sharpe Ratio Sortino Ratio Calmar Ratio 233.93 17.56 0.69 1.07 0.27 83.49 15.28 0.36 0.51 0.12 — — — — — Best Month Worst Month Best Quarter Worst Quarter % of Up Month % of Down Month Avg Monthly Gain Avg Monthly Loss Gain Std Dev Loss Std Dev 18.54 -19.75 24.74 -23.73 62.50 37.50 4.00 -3.78 10.89 13.21 10.88 -16.84 15.72 -22.13 60.83 39.17 3.27 -3.64 8.43 11.81 — — — — — — — — — — Longest Up Streak (Mo) Run Up % Start Date End Date 8 38.39 9/2010 4/2011 7 16.61 11/2012 5/2013 — — — — Longest Down Streak (Mo) Run Down % Start Date End Date 5 -18.14 5/2011 9/2011 5 -16.49 5/2011 9/2011 — — — — 16 -47.95 11/2007 2/2009 16 -51.44 11/2007 2/2009 — — — — Max Drawdown (Mo) Max Drawdown (%) Peak Date Valley Date Excess Return Alpha Beta R-Squared Tracking Error Information Ratio Treynor Ratio Up Capture Ratio Down Capture Ratio Up Number Ratio Down Number Ratio Up Percentage Ratio Down Percentage Ratio Tracking Error 0 B-mark 2% 11.23 Relative Performance 1/1/2007 to 12/31/2016 Information Ratio 0 B-mark 1% Return/Risk Analysis 1/1/2007 to 12/31/2016 Rolling Performance 1 months per calculation 2008 Inv % 14.66 YTD Peer Group — — Top Quartile 2nd Quartile 3rd Quartile Bottom Quartile 90% of Category 8 2007 Morningstar Category — Trailing Returns as of 12/31/2016 56 -98 Benchmark 2 — 2008 2009 2010 2011 2012 2013 2014 2015 B-mark 2 6.56 5.64 1.12 94.46 4.51 1.45 10.85 — — — — — — — 122.88 95.99 0.96 0.89 0.71 0.66 — — — — — — 2016 © Morningstar 2017. All rights reserved. Use of this content requires expert knowledge. It is to be used by specialist institutions only. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results. 6 B-mark 1 ß ®
8. DESCRIPTION OF THE CATHOLIC VALUES BACK-TESTED PORTFOLIO The returns are based on a 10-year back-tested model portfolio starting 12 /31/06 ending 12/31/16. The model portfolio uses Catholic Values governance scores as of 12/31/16 and the portfolio allocations were based on these scores. Rebalancing was performed monthly based on closing prices at month-end. Trading costs and imputed commissions were not included. The model’s universe contains companies from the S&P 500 index as of 12/31/16. 7
9. Morningstar DirectSM | Print Date: 1/19/2017 Page 1 of 1 Magni Islamic Stewardship Back-Tested Portfolio Currency USD Performance Evaluation Benchmark 1 S&P 500 Shariah TR USD Return vs Peer Group 32 8 -16 -40 Subject Investment Benchmark 1 Benchmark 2 Peer Group — — Top Quartile 2nd Quartile 3rd Quartile Bottom Quartile 90% of Category 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016-06 History 17.39 15.00 4.90 -30.59 -31.29 -37.45 50.17 26.79 25.55 27.56 12.61 14.37 6.70 4.27 1.47 21.96 12.28 15.22 40.72 31.74 31.55 16.18 13.37 12.99 -0.35 2.06 0.75 5.82 3.10 3.49 Subject Investment Benchmark 1 Benchmark 2 — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — Peer Group Avg Best 25th Percentile 50th Percentile 75th Percentile Worst — — — — — — — — — — Gross Expense Ratio 440 306 172 38 2007 Name 2008 2009 Total # of Calculations 120 120 120 Subject Investment Benchmark 1 Benchmark 2 2010 % in Top Quartile 0.00 0.00 0.00 2011 % in 2nd Quartile 0.00 0.00 0.00 2012 % in 3rd Quartile 0.00 0.00 0.00 2013 2014 % in Btm Quartile 2015 % Above B-mark 1 0.00 0.00 0.00 2016 % Above B-mark 2 64.17 — — 68.33 — — 3 2 1 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 3 2 1 2006 B-mark 2% 3.10 3.49 1 Month 3 Months 6 Months 0.04 2.19 5.82 -0.07 1.42 3.10 0.21 2.29 3.49 1 Year 2 Years 3 Years 4 Years 5 Years 10 Years 3.27 6.49 14.06 17.16 15.15 14.57 4.08 5.30 12.23 13.21 11.47 8.76 3.31 5.02 10.95 13.10 11.38 6.74 Inv B-mark 1 B-mark 2 Cumulative Return Standard Deviation Sharpe Ratio Sortino Ratio Calmar Ratio 289.65 16.29 0.84 1.34 0.35 131.61 14.29 0.55 0.80 0.21 91.93 15.24 0.38 0.54 0.13 Best Month Worst Month Best Quarter Worst Quarter % of Up Month % of Down Month Avg Monthly Gain Avg Monthly Loss Gain Std Dev Loss Std Dev 14.66 -17.96 20.06 -22.95 65.83 34.17 3.74 -3.69 10.17 12.02 10.75 -14.84 12.76 -18.04 63.33 36.67 3.18 -3.44 7.93 10.82 10.88 -16.84 15.72 -22.13 62.50 37.50 3.22 -3.76 8.34 11.89 Longest Up Streak (Mo) Run Up % Start Date End Date 8 42.19 9/2010 4/2011 8 32.71 9/2010 4/2011 7 16.61 11/2012 5/2013 Longest Down Streak (Mo) Run Down % Start Date End Date 5 -16.45 5/2011 9/2011 5 -15.13 5/2011 9/2011 5 -16.49 5/2011 9/2011 Max Drawdown (Mo) Max Drawdown (%) Peak Date Valley Date 9 -41.92 6/2008 2/2009 16 -42.41 11/2007 2/2009 16 -51.44 11/2007 2/2009 Excess Return Alpha Beta R-Squared Tracking Error Information Ratio Treynor Ratio Up Capture Ratio Down Capture Ratio Up Number Ratio Down Number Ratio Up Percentage Ratio Down Percentage Ratio Tracking Error 0 B-mark 1% 5.82 Relative Performance 7/1/2006 to 6/30/2016 Information Ratio 0 Inv % YTD Return/Risk Analysis 7/1/2006 to 6/30/2016 Rolling Performance 1 months per calculation 2006 Morningstar Category — Trailing Returns as of 6/30/2016 56 -96 Benchmark 2 S&P 500 NR USD 2007 2008 2009 2010 2011 2012 2013 2014 2015 B-mark 2 5.81 4.75 1.09 91.94 4.82 1.20 12.45 7.83 7.07 1.03 93.48 4.20 1.87 13.18 118.92 95.02 0.92 0.80 0.64 0.64 118.33 84.00 0.92 0.78 0.67 0.71 2016 © Morningstar 2017. All rights reserved. Use of this content requires expert knowledge. It is to be used by specialist institutions only. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results. 8 B-mark 1 ß ®
10. DESCRIPTION OF THE ISLAMIC STEWARDSHIP BACK-TESTED PORTFOLIO The returns are based on a 10 year back-tested portfolio starting 6 /30/06 ending 6/30/16. The portfolio uses Islamic Stewardship governance scores as of 6/30/16 and the portfolio allocations were based on these scores. The rebalancing was monthly and based on closing prices at month-end. Trading costs and imputed commissions were not included. The model’s universe contains stocks in the S&P 500 index that were rated as Shariah-compliant of as 6/30/16 by a leading global custodial bank. 9
11. Morningstar DirectSM | Print Date: 4/13/2017 Page 1 of 1 Magni Corporate Governance Back-Tested Portfolio Currency USD Performance Evaluation Benchmark 1 S&P 500 NR USD Return vs Peer Group Subject Investment Benchmark 1 Benchmark 2 32 -16 -40 History 2007 2008 2009 2010 2011 2012 2013 2014 10.85 4.90 — -33.76 -37.45 — 49.99 25.55 — 25.87 14.37 — 3.13 1.47 — 22.33 15.22 — 40.95 31.55 — 18.31 12.99 — 2015 2016-12 0.02 0.75 — 14.51 11.23 — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — Peer Group Avg Best 25th Percentile 50th Percentile 75th Percentile Worst — — — — — — — — — — Gross Expense Ratio Subject Investment Benchmark 1 Benchmark 2 702 502 302 102 Name 2009 Total # of Calculations Subject Investment Benchmark 1 Benchmark 2 120 120 0 2010 2011 % in Top Quartile 2012 % in 2nd Quartile 0.00 0.00 — 2013 % in 3rd Quartile 0.00 0.00 — 0.00 0.00 — 2014 % in Btm Quartile 0.00 0.00 — 2015 % Above B-mark 1 68.33 — — 2016 % Above B-mark 2 0.00 — — 3 2 1 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 3 2 1 2007 — 1 Month 3 Months 6 Months 1.06 3.86 8.78 1.93 3.65 7.48 — — — 1 Year 2 Years 3 Years 4 Years 5 Years 10 Years 14.51 7.02 10.66 17.56 18.50 12.82 11.23 5.86 8.18 13.60 13.92 6.26 — — — — — — Inv B-mark 1 B-mark 2 Cumulative Return Standard Deviation Sharpe Ratio Sortino Ratio Calmar Ratio 234.01 17.56 0.69 1.07 0.27 83.49 15.28 0.36 0.51 0.12 — — — — — Best Month Worst Month Best Quarter Worst Quarter % of Up Month % of Down Month Avg Monthly Gain Avg Monthly Loss Gain Std Dev Loss Std Dev 18.51 -19.78 24.79 -23.78 62.50 37.50 4.00 -3.78 10.89 13.23 10.88 -16.84 15.72 -22.13 60.83 39.17 3.27 -3.64 8.43 11.81 — — — — — — — — — — Longest Up Streak (Mo) Run Up % Start Date End Date 8 38.48 9/2010 4/2011 7 16.61 11/2012 5/2013 — — — — Longest Down Streak (Mo) Run Down % Start Date End Date 5 -18.15 5/2011 9/2011 5 -16.49 5/2011 9/2011 — — — — 16 -47.97 11/2007 2/2009 16 -51.44 11/2007 2/2009 — — — — Max Drawdown (Mo) Max Drawdown (%) Peak Date Valley Date Excess Return Alpha Beta R-Squared Tracking Error Information Ratio Treynor Ratio Up Capture Ratio Down Capture Ratio Up Number Ratio Down Number Ratio Up Percentage Ratio Down Percentage Ratio Tracking Error 0 B-mark 2% 11.23 Relative Performance 1/1/2007 to 12/31/2016 Information Ratio 0 B-mark 1% Return/Risk Analysis 1/1/2007 to 12/31/2016 Rolling Performance 1 months per calculation 2008 Inv % 14.51 YTD Peer Group — — Top Quartile 2nd Quartile 3rd Quartile Bottom Quartile 90% of Category 8 2007 Morningstar Category — Trailing Returns as of 12/31/2016 56 -98 Benchmark 2 — 2008 2009 2010 2011 2012 2013 2014 2015 B-mark 2 6.56 5.64 1.12 94.46 4.51 1.45 10.85 — — — — — — — 122.90 96.00 0.96 0.89 0.71 0.64 — — — — — — 2016 © Morningstar 2017. All rights reserved. Use of this content requires expert knowledge. It is to be used by specialist institutions only. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results. 10 B-mark 1 ß ®
12. DESCRIPTION OF THE MAGNI CORPORATE GOVERNANCE BACK-TESTED PORTFOLIO The returns are based on a 10-year back-tested model portfolio starting 12 /31/06 ending 12/31/16. The model portfolio uses Magni corporate governance scores as of 12/31/16 and the portfolio allocations were based on these scores. Rebalancing was performed monthly based on closing prices at month-end. Trading costs and imputed commissions were not included. The model’s universe contains companies from the S&P 500 index as of 12/31/16. 11
13. Surprise : Those ‘Great’ Companies Generally Turn Out To Be Meh ... or Duds After all the hoopla, McKinsey finds that over the long run, most struggle to outperform the S&P 500   By Chris Bradley Published Linked In: July 23, 2017 8:40 a.m. ET (Chris Bradley is one of the global leaders in McKinsey’s Strategy Practice and co-developer of the Ten Timeless Tests of Strategy.) What happened to the world’s “greatest” companies? the case when I tell them Kodak was once one of the most respected companies on earth. … To see how these great companies fared, our research team dug out their share price and dividend data, and assessed their performance 20 years after the books’ publication (or, in the case of “Good to Great,” 15 years up to December 2016). We then created a “buy and hold” portfolio of $100 invested in each stock. If a stock had been de-listed, we assumed the closing amount was reinvested into the index. Let’s call these portfolios ISOE, BTL and GTG, after their respective books. Three books sit on more executives’ bookshelves than any others: “In Search of Excellence” (1982), “Built to Last” (1994), and “Good to Great” (2001). They turned their authors into management gurus, especially Tom Peters (“In Search of Excellence”) and Jim Collins (the other two titles). All three use the same basic method: list companies that are “great” or “excellent” or “enduring,” then attempt to infer the transferable formulae behind said greatness, excellence and endurance. … But what actually happened to them? So what did we find? If you bought a portfolio of these companies and held them for two decades, you would have beaten the S&P 500 index by 1.7 percentage points. Not bad! GTG is in the lead at a 2.6 percentage-point outperformance, followed by BTL at 1.6 percentage points and ISOE at 1.5 percentage points. … Our three books mention 50 companies — well, actually 60, but 10 of them get the honor of appearing twice (in fact, half of the “Built to Last” companies were in “In Search of Excellence” almost a decade before). This combined list is interesting in itself. When I talk to our newest batch of McKinsey recruits about a great company called Wang Labs that made these things called mainframes and word processors, they look at me like I’m strange. This is even more But this rosy picture looks a little different up close—as experienced by the companies themselves. Their fates could not have diverged more: 12
14. Performance of the “excellent,” “lasting” and “great” companies vs. the S&P “In Search of Excellence”  (1982-2002) Wal-Mart Intel Merck Johnson & Johnson “Built to Last” (1994-2004) Philip Morris Marriott “Good to Great”  (2001-2016) Phillip Morris Nucor     Outperformers (more than 2 percentage points better than the market)     Procter & Gamble Avon Products Walt Disney DuPont 3M     American Express Johnson & Johnson IBM Wal-Mart Nordstrom 3M     Kroger Wells Fargo     Middle     Dow Chemical Bristol-Myers Squibb Boeing Amoco (a) Emerson Electric McDonald’s Caterpillar Texas Instruments     Procter & Gamble Boeing Walt Disney Merck Hewlett Packard General Electric     Gillette (a) Kimberly-Clark Walgreens Abbott Labs     Underperformers (more than 2 percentage points worse than the market     Maytag (s) Hewlett-Packard IBM Delta Air Lines (s)     Ford     Failures (more than 5 pct. pts. worse than the market)     Schlumberger Kodak (s) Raychem (a)     Amdahl (a) Dana (s) National Semiconductor (a) DEC (a) Data General (a) Kmart (b) Wang Labs (b)     Citicorp Motorola Sony Stars (more than 5 percentage points better than the market)     Key (a) Acquired during  evaluation period (b) went bust during  evaluation period (s) subsequently acquired  or went bust We came to some interesting, even surprising, conclusions. Great companies were more likely to do really badly than really well. Their odds of outperforming the stock market were 52-48, hardly better than a coin toss. But there are more big losers than big winners on the lists. Just eight companies outperformed the index by more than 5 percentage points, while twice that number underperformed by the same percentage. Given the difficulty of beating the market, it’s no surprise that the biggest group is in the middle band of plus or minus 2 percentage points. 13     Pitney Bowes Fannie Mae Circuit City (b)
15. A few great companies is all it takes for a portfolio to outperform . So if the typical company didn’t do so well, why did the portfolios outperform? The magic of compounding means a few extremely good stocks can offset many poor ones. When you take the four best performers—actually, three companies: Wal-Mart and Intel in ISOE, and Philip Morris which appears in both GTG and BTL—out of the portfolios, the positive margin almost completely disappears. In other words, if it were not for cigarettes, Jim Collins’s outperformance would literally go up in smoke. This elite group of four would end up being worth 27% of the 60-company portfolio. 14
16. Outro : The Business of Gardening “Humility is the awareness that there’s a lot you don’t know and that a lot of what you think you know is distorted or wrong.”  ― David Brooks, The Road to Character For a garden to be fully successful, a holistic approach needs to be taken. Much as a businessperson cannot focus solely on shareholders or only employees, a farmer can not only focus on fertilizing his crops or just planting seeds. This month’s issue of Pegasus presents an amazing set of data validating what the Caux Round Table for Moral Capitalism (CRT) has been working on promoting for decades. It also brought to mind the above quotation from David Brooks. Volkswagen cannot simply focus on emissions standards and seek workarounds for testing – neglecting numerous stakeholders. The piece from Chris Bradley exemplifies the idea that ‘a lot of what you think you know is distorted or wrong.’ True success in the world of business is not simply about selling products and services and being recognized for that – as one might initially think – through revenue. As Bradley and the Magni results show, it is much more than that; it is about all of a company’s stakeholders. BP cannot simply focus on short term profits, neglecting the safety and maintenance of their wells. These types of decisions – and short-termism, in general – cause lasting damage to a variety of stakeholders. The article’s authors continue that “by focusing our attention on the long term over the short, on the power of markets to create wealth through evolutionary adaptations and on the health of the whole rather than a part, it gives us prosperity that is widely shared, sustained and self-reinforcing.” As Steve outlined in his introduction, the responsibilities for a company are myriad – customers, employees, shareholders, suppliers, etc. The type of holistic approach necessary for long term, sustainable success reminded me of an article I read in the New York Times a short time ago. The data from Magni show us that using a holistic approach is more successful. Pulling the weeds of corruption and immorality, planting the seeds of employee engagement, and applying the fertilizer of commitment to community are shown to be effective means for long-term sustainable success in business. You simply have to do it all otherwise your profits will rot on the vine. The article, ‘The Machine and the Garden,’ starts by noting that for much of the recent past we have used metaphors to talk about the economy, and business, such as “economic engines,” “fueling a recovery,” and progress “stalling.” The authors refer to this as “Machinebrain.” They note that these types of metaphors paint a picture of the world where “markets are perfectly efficient, humans perfectly rational, incentives perfectly clear and outcomes perfectly appropriate.” As Brooks references above, there are many things that we believe that we know to be true that are actually distorted or wrong. We need to have the humility to realize the errors, look at the new data and move forward holistically. The authors go on to state that economies “as social scientists now understand, aren’t simple, linear and predictable, but complex, nonlinear and ecosystemic. An economy isn’t a machine; it’s a garden. It can be fruitful if well-tended, but will be overrun by noxious weeds if not.” The same can be said for individual businesses as well. Erik Sande Caux Round Table For Moral Capitalism 15
17. Final Thought : 16
18. Published by the Caux Round Table Editor in Chief Stephen B . Young Editor Erik Sande Assistant Editor Jed Ipsen Design, Layout, and cover photos by Erik Sande