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Building Trust Into Investment Decision-Making

Defining Trust-Based Investing

Why do individual investors remain passive bystanders, watching from the sidelines and off the stock market field? Could it be concerns about valuation, liquidity, profits, or something else? The answer is simple. Individual investors have no reason to trust public companies. High-profile accounting scandals, out-of-touch compensation practices, corporations dodging taxes and a leveraged lending orgy led to a global financial meltdown, and little has been done since 2009 to fix the problem. Is it any wonder that trust in the financial markets has all but disappeared?

In 2008, The Economist published a briefing paper sponsored by Cisco, called “The Role of Trust in Business Collaboration,” stating that tens of millions of dollars had been spent evaluating corporate governance, but a definition of corporate trust continues to elude us. What if companies could be identified that exhibited high levels of trust-“worthiness”?

What's different about Trust-Based Investing?

U.S. stock markets are fundamentally attractive. Most of the leading economic indicators point to a stronger economy and that in turn may create increasing optimism for the stock market. But still, the money remains parked in low-yielding money market accounts. By delivering a “beyond reproach” strategy to investors combining the key indicators of corporate trustworthiness, Trust-Based Investing could become the solution the public has been waiting for.

Why Trust Matters in Investing

Trust matters in every transaction, with every person, every day. Why should Trust-Based Investing be any different? Companies that embrace trust as a business imperative reap the following rewards:

Improved Profitability

Building a trustworthy business will improve a company’s profitability and organizational sustainability. A growing body of evidence shows increasing correlation between trustworthiness and superior financial performance. Over the past decade, a series of qualitative and quantitative studies have built a strong case for senior business leaders to place building trust among stakeholders high on their priority list. While none of these studies are perfect, over the next decade their results will be increasingly difficult to ignore.

A 2013 study by Guiso, Sapienza and Zingales called The Value of Corporate Culture finds that proclaimed values appear irrelevant. Yet, when employees perceive top managers as trustworthy and ethical, a firm’s performance is stronger.

In a Harvard Business School working paper from July 2013 called The Impact of Corporate Sustainability on Organizational Processes and Performance, Robert G. Eccles, Ioannis Ioannou and George Serafeim provide evidence that high sustainability companies (those integrating both environmental and social issues) significantly outperform their counterparts over the long term, both in terms of stock market as well as accounting performance.

According to a 2011 Booz & Co. study, The Global Innovation 1000: Why Culture Is Key, companies with both highly aligned cultures and highly aligned innovation strategies have 30 percent higher enterprise value growth and 17 percent higher profit growth than companies with low degrees of alignment.

Higher Employee Engagement

A global study carried out by Towers Perrin-ISR 50 compared the financial performance of organizations with more engaged workforces to their peers with less engaged workforces over a period of 12 months. The data comprised of 664,000 employees from 50 companies, of all sizes, around the world, representing a range of different industries. Engagement was measured alongside more traditional business performance measures such as operating income, net income and earnings per share. Towers Perrin-ISR’s findings included the following:

1) Those companies with a highly engaged workforce improved operating income by 19.2 percent over a period of 12 months, while those companies with low engagement scores saw operating income decline by 32.7 percent over the same period; and

2) Those companies with high engagement scores demonstrated a 13.7 percent improvement in net income growth, while those with low engagement saw net income growth decline by 3.8 percent.

Lower Cost of Capital and Less Risk

From Deutsche Bank: 100 percent concurrence on Lower Cost of Capital (“… academic studies agree that companies with high ratings for CSR (corporate social responsibility) and ESG (environment, social responsibility, governance) factors have a lower cost of capital in terms of debt (loans and bonds) and equity.”)

Higher Return on Equity and Return on Assets

From Global Alliance for Banking on Values, which compared values-based and sustainable banks to their big-bank rivals and found: 7 percent higher Return on Equity for values-based banks (7.1 percent ROE compared to 6.6 percent for big banks) and 51 percent higher Return On Assets for sustainable banks (0.50 percent average ROA for sustainable banks compared to big bank earning 0.33 percent).

The Benefits of Trust-Based Investing

Trust-Based Investing works, but not just for the obvious reason of producing outstanding returns to investors. By investing in trustworthy companies, a virtuous cycle is created. As money flows into the hands of these companies, other companies will want to follow suit. They will have no choice but to elevate their level of organizational trust. Trust works in all relationships, even in financial services.

 

Jordan Kimmel & Barbara Brooks Kimmel are Managing Members of FACTS Asset Management, a N.J.-registered Registered Investment Advisory that is focused on using a three-component trust model of character, competence and consistency in all investment decisions and operations.

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