Investment

Why family businesses pay the price of an overleveraged global economy

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According to research by Credit Suisse, family-controlled businesses outperform over time by taking a long view of prospects, limiting their leverage and investing in their businesses.

Their relative performance can be particularly good in emerging markets, where family influence can redress weak corporate governance standards elsewhere.

It is an unfortunate truth that listed family businesses will always be vulnerable to the impact of short-term behaviour of market participants

Family businesses do not need to try too hard to impress the market. Share buy-backs carried out by family companies to boost their share prices were 6.8% of cash flow in 2017, against 15.8% for non-family companies, says Credit Suisse.

But it is an unfortunate truth that listed family businesses will always be vulnerable to the impact of short-term behaviour of market participants. Twas ever thus.

Unusually, shares in family-controlled businesses lost ground compared to market indices last year. Funds which invest in family businesses skidded into the fourth quartile of performance compared to their peers.

This is probably because family companies tend to underperform during periods when economic conditions and stock market sentiment are rising and leverage makes everyone else look smart.

But hopes for sustained growth were dashed in December, when the Federal Reserve tried to tighten money supply, only to be greeted with the extraordinary hike in high-yield bond spreads.  

The Fed has now reversed its policy, to push down borrowing costs, as Europe and China take steps to stimulate their economies, all over again.

Volatility has fallen, and the market has relapsed into a familiar state of anxious equilibrium.

The backdrop is certainly worrying. You only need to look at corporate debt, now worth a record $13 trillion, or twice the level reached in 2008. Which represents an awful lot of debt to service, if recovery doesn’t happen.

In a February report, the OECD warned issuance was running at $1.7 trillion a year, double the levels seen before the financial crisis. Half this total has a low credit rating, which suggests that refinancing problems will be big, unless rates stay low.

It is also worrying to see an increase in the number of profit warnings announced by companies, fuelling the kind of anxiety which can lead to a full-blown recession.

According to EY, companies listed in the UK suffered an average share price fall of 22% on the day of a profit warning, in the fourth quarter of last year.  This was a record. EY said: “Downside risks are increasing and changing market mindsets.”

At 287, the number of profit warnings in the UK in 2018 were the highest for three years. Much of the damage was caused in the retail sector, suffering due to disruption, construction and outsourcing, where a squeezed public sector is squeezing its suppliers.  

But serious price falls followed warnings from companies in more resilient sectors, such as Walgreens, Samsung and Saga. Ladbroke Coral owner CVC fell by a fifth in a single day when two directors sold a chunk of their stock.  Online payments firm Wirecard has been hit despite denying media criticism of its accounting practices.

Investors often blame excessive price reactions on technical changes in the market place. For example, trading has become automated: it has become quick to respond to changes in sentiment rather than underlying prospects. Market makers are reluctant to bet against price falls, due to regulatory pressures on capital.

Long-term institutional investors are fewer in number and less willing to prop up the market: average stock holding periods have fallen to eight months. Analyst notes have fallen in quality and quantity, due to regulation, undermining the sourcing of information as managers struggle to make sense of big data.

All this, and all that debt, are capable of producing a dash for the market’s exit by investors following bad news, as we saw during the price rout of 2008.  Add in political uncertainty, and the price fall will surely have a growing impact on family businesses in the years ahead. And it isn’t even their fault.

 

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