Comment

Comment

As the days of the current bull market appear numbered, investors need a strategy to see them through more volatile times. By Cormac Lucey The Capital Asset Pricing Model (CAPM) contends that the risk involved in buying any financial asset can be divided into diversifiable risk (which can be effectively eliminated if you spread your investments sufficiently) and non-diversifiable risk (which is the specific, non-market risk associated with the asset). Financial studies tend to focus on the non-diversifiable risk element (measured by beta), as this is a key driver of the security’s cost of equity and thus, of its cost of capital. Many market practitioners, by contrast, concentrate instead on the overall direction of the market. Get that right, and you are likely to make money even if your choice of assets is poor. Get that wrong, and even a good choice of assets may go unrewarded. Berkshire Hathaway is an example of a great stock to have owned over recent decades – over the last 31 years, its share price has risen at a compound annual growth rate of just over 18%. But you would have suffered significant losses if you had held the stock during the last two equity bear markets: between March 1999 and February 2000, its share price dropped 44%; and between December 2007 and March 2009, it fell 47%. What do today’s investment signals indicate about prospective equity returns? Excuse me if the following analysis is USA-centric, but in general global equity bear markets begin and end in the USA. Looking at America, there are two clear warning signs that the days of the current bull market – which commenced over a decade ago, in March 2009 – are numbered. The first warning sign concerns the US unemployment rate. There is a clear pattern over the last half-century that US recessions and bear markets occur after a prolonged fall has brought the American unemployment rate below 5%. There is also an established relationship between the US unemployment rate and one-year equity returns: if the US unemployment rate exceeds 7%, average annual returns exceed 11%, but if the unemployment rate is below 4.5%, average returns are just 1.3%. As of September, the US unemployment rate was a mere 3.5%. The logic of this relationship is that, while lower rates of unemployment are good for workers and society, they can stoke wage inflation, business costs and thus central bank interest rates. The negative effects exert a negative influence on equity values. The second warning comes from the yield curve. It depicts the annual rate of interest investors can get from US government bonds of differing maturities. Normally, investors get a higher rate of interest when they expose themselves to greater risk by purchasing government bonds of longer maturities. Very occasionally, we get an inverted yield curve, when the rate of interest on short-dated government bonds exceeds that on longer-dated ones. Inverted yield curves have, in the last 50 years, been unfailing warnings that a US recession will occur within 24 months. In recent months, the US yield curve has inverted. While these two warnings strongly indicate a US equity market peak sometime within the next two years, neither signals the need to head for the exit door immediately. Indeed, some of the largest investment gains can be made towards the very end of bull markets. Citi Research maintains a Bear Market Checklist of 18 different signals. In March 2000, 17.5 of the signals were flashing red. In October 2007, it was 13. In September, just four of their 18 indicators were signalling warnings. This suggests that investors should remain positive on equities, but they should also plan now what their investment strategy would be in a bear market. Will they reduce their equity exposure, switch entirely to bonds and cash or are they willing to short the market (and seek to profit from falling equity values)? Investors now need to shorten their investment horizon and switch from a long-term buy and hold strategy (which works wonderfully over prolonged bull markets) to a short-term tactical approach (which will be more suited to the choppy investment waters that appear to be ahead). Cormac Lucey FCA is an economic commentator and lecturer at Chartered Accountants Ireland.

Dec 03, 2019
Comment

Claire Lord explains how the outcome of a recent court decision clearly articulates the meaning of a director’s “independence of mind”. It is a fundamental and long-standing principal of common law, and more recently a principal enshrined in statute, that directors owe their duties to the company of which they are a director and to the company alone. Directors may come to owe particular duties to others in particular circumstances, such as to shareholders where there are negotiations for a takeover and the directors should act to promote the interests of the shareholders in agreeing a deal that best reflects the value of the company, or to creditors where the directors are aware that the company is insolvent and its assets should be preserved to the extent possible to settle its liabilities. There is also a statutory duty placed on directors to have regard to the interests of members and employees when performing their functions. There is, however, no mechanism for members or employees themselves to enforce this statutory duty unless, in the case of members, they can muster sufficient voting power to compel the directors to have regard to them or, in the case of employees, where a liquidator does so on their behalf. The result of these principles in practice is that, on a day-to-day basis and when the business of a company is running in the ordinary course, the directors need, at all times, to be making decisions on business strategy that are in the best interests of the company. While a company’s shareholders and employees will have an interest in the outcome of a company’s strategy, they have no direct responsibility for the impact on the company of a course of action taken. It follows, therefore, that where directors of an Irish company act in breach of their duties to the detriment of the company, the proper plaintiff to seek recourse is the company itself. Collective independence In performance of their duties owed to a company, the directors act as a collective in the interests of the company. In doing so, directors must exercise independent judgement. These concepts of togetherness and independence are not contradictory; the requirement is simply for each individual director to bring their own independence of mind to the deliberations of the collective. Behaviours that demonstrate independence of mind include having conviction and strength to effectively assess and challenge decisions of other directors; the ability to ask questions of those closer to the executive function of the company or to certain aspects of that executive function; and, very importantly, the ability to resist group-think, all with a view to ensuring that decisions made by the board are in the best interests of the company. Exercising independent judgement does not mean forming a view independent to that of the board as a whole and then acting independently to achieve a particular outcome in support of that view. A court’s view The High Court of England and Wales recently considered the scope of directors’ duties, and more particularly the duty of a director to exercise independent judgement, in proceedings that arose out of a boardroom battle within Stobart Group Limited, the publicly quoted logistics group. The proceedings concerned a dissenting director who formed an independent view on a company matter and sought to involve shareholders and employees in matters of corporate strategy that fell outside their purview. The specific actions taken by this director included criticising the board’s management to the company’s majority shareholders, agitating these shareholders for the removal of the company’s chair and improperly sharing confidential company information with a non-board member. All of these actions were taken independent of the board of the company. The judgment delivered noted that the duty to exercise independent judgement is one that must be performed by a director in the context of the board of directors acting as a collective. The judgment also noted that this obligation does not carry with it some kind of entitlement for an individual director to act independently of the board in relation to matters that fall within the sphere of management of the company’s business. The judgment correctly concluded that an individual director should raise, debate, reflect upon and then decide on their own position on a matter at the level of the board, either as part of the majority or as a dissenting voice. Only by doing so will they be able to comply with their duties to exercise an independent judgement and to act in the best interests of the company.   Claire Lord is a Corporate Partner and Head of Governance and Compliance at Mason Hayes & Curran.

Dec 03, 2019
Comment

Des Peelo outlines why prospective sellers and buyers should not rely on rules of thumb as a basis for the valuation of a business. Commentators, financial analysts, investment advisors and others often like to believe, or at least promulgate the belief, that the valuation of a business in a particular sector can be stated as some simple formula such as ‘X times turnover’, a percentage of something, or a multiple per unit (that unit being a hotel room, a subscriber and so on). Sometimes, advisors charge extraordinary fees for imparting such wisdom in an apparently knowledgeable manner. This wisdom is known collectively as ‘rules of thumb’. Common sense dictates that the reason for acquiring a business, or an interest in a business, is to obtain an economic return (i.e. future profits). However, the use of rules of thumb in valuing a business is at best arbitrary, is not based on economic assessment, and carries little if any logic beyond being a kind of shorthand valuation usually put about within the business sector itself. Financial press commentators too can create a norm by simply relating the sale price of a particular business to some underlying statistic in the business, such as the price being a certain multiple of the turnover, the price per hotel room, the number of subscribers divided into the price, the price expressed as a percentage of the amount of funds under management. This norm, having been published and thereby accorded a status, is then perceived as a comparison or benchmark for any future transactions in the same sector, even where it bears little relation to the reality of the marketplace. The underlying premise to a rule of thumb basis of valuation, if there can be a premise at all, has to be a belief that profitability in the sector does not vary greatly and that therefore, almost any company in the sector will have the same characteristics. This is obviously irrational because the following factors may differ:  Rented versus owned premises; Different levels of borrowings; Young versus mature businesses; Use of technology; New versus old equipment; and Age and experience profiles of key employees. A norm is an average. An average, by definition, includes high and low and does not distinguish between a good and a bad business. An average is not excused by saying that it relates to a typical business. A business may be described as typical only insofar as it has, for example, a turnover or characteristics similar to other businesses in the same sector. However, one or two common characteristics do not negate the differences between businesses, as set out above. A potential purchaser should be wary of a valuation based on a rule of thumb approach. Examples abound of unwise acquisitions made by following such an approach, sometimes referred to as ‘formula purchases’. In the UK, the practice of ‘formula purchases’, now much more muted, included undertakers, hotels, pubs and restaurant chains, recruitment agencies, insurance brokerages, advertising agencies, estate agents, newspapers, pharmacies and even nursing homes. A high proportion of these acquisitions subsequently unravelled. It was mainly ‘people businesses’ (such as estate, advertising and recruitment agencies) that lost the most money for their new owners. It can be the case, however unscientific, that certain valuations are based and/or accepted on something akin to rules of thumb. For example, the Revenue work manual on the valuation of shares regarding Capital Acquisitions Tax states the following: “Companies which own or operate licensed premises or restaurants or whose business is in the services sector, such as insurance brokers, quantity surveyors, architectural practices, consulting engineers, legal etc. are normally valued on the basis of a multiple of their turnover, fees or commissions.” In the case of a professional practice, notably accountants and solicitors, the valuation is probably seen as a price for giving a new entrant a head-start in the business; or alternatively providing a bolt-on addition to an existing practice. Experience suggests that there is some fall-off in respect of repeat business when a practice changes hands. Hence, a transaction on a rule of thumb valuation that is based on expected repeat fees may defer some of the consideration based on the actual outcome. Any fall-off is usually ameliorated, however, by parallel working for a period with the outgoing practitioner. In summary, relying on a rule of thumb as a basis for valuation is flawed. If a rule of thumb is to have any use at all, it can be no more than a preliminary indication of a seller’s expectation of price. This expectation must be met by the reality that a valuation is about market value, not a pre-ordained norm. A potential purchaser, properly advised, will not buy solely on a rule of thumb valuation. Des Peelo FCA is the author of The Valuation of Businesses and Shares, which is published by Chartered Accountants Ireland and now in its second edition.

Dec 03, 2019
Comment

Travel is a critical enabler in our efforts to tackle the climate crisis, however contrary that might seem. Brian Keegan explains why. We may need to increase our carbon footprint. This thought occurred to me some 35,000 feet over the Atlantic but is perhaps none the less valid for it. By now, no one can deny that climate change is real. Denying it is the 21st century equivalent of suggesting that the sun won’t rise tomorrow unless something (or someone) is sacrificed. I don’t believe, however, that mankind’s role in the climate change challenge will be resolved by not travelling. We are social animals and cannot work together, sustain our families or feed our intellects without some degree of travel. I don’t know any parent who wouldn’t undertake a school run purely on the grounds of minimising their carbon footprint. Nor do I know anyone who would decide not to visit an elderly parent for fear of the carbon emissions from the car journey they might have to make. The challenge for “clean” energy Well over half a century ago, the psychologist, Abraham Maslow, proposed a hierarchy of human needs. These range from basic needs like food, water and shelter and then onwards up the hierarchy towards a notion of self-actualisation. Self-actualisation is all about developing and using abilities and talents. The theory goes that people tend to attend to the more basic needs at the bottom of the hierarchy first, and then move upwards. In the past, travel might have been more linked with activities at the top of the hierarchy. However, climate change may have snookered that perspective as using abilities and talents become more fundamental to securing routine shelter and safety. The snag is that travel is now inseparably associated with the release of unwelcome levels of CO2 into the atmosphere, with the attendant consequences of climate change. The problem, though, is not the release of CO2 from the combustion engines used in most types of travel. Instead, the problem is one of fuel portability. Fossil fuels – the liquid hydrocarbons like petrol and diesel – are popular because they are easy to store and replenish, and relatively small quantities can deliver useful distances (as anyone who has ever suffered range anxiety in an electric car will confirm). The technology exists to generate “clean” energy without releasing carbon into the atmosphere – solar, hydro, wind. Even nuclear works, depending on your definition of “clean”. The biggest technical challenge now is not clean energy. Rather, it is how to deliver the clean energy currently being generated in a format that is widely suitable for transport.   “You can’t email a handshake” Greta Thunberg’s contribution to the tackling of climate change this year was not so much her address to the United Nations. Nor was it her publicity stunt to sail to New York to make her speech, rather than fly there like the rest of us. Her contribution was to acknowledge the fact that people need to travel to collaborate to find solutions and make an impact. As Tyrone manager, Mickey Harte, pointed out at an Institute event some time ago, you can’t email a handshake. If societies decide not to promote the kind of human association that is required to tackle climate change by putting embargoes or levies on travel, the problems will never be solved. Little progress can be made without socialisation. Colleagues here at the Institute are currently examining the issues associated with sustainability reporting by businesses and firms. What gets measured gets done. It’s just one example of the collaboration needed at every level of industry to resolve environmental issues. This will never be achieved if, to save the planet, we all decide just to stay at home. Dr Brian Keegan is Director of Advocacy & Voice at Chartered Accountants Ireland.

Dec 03, 2019
Comment

As the end of 2019 approaches, we reflect on what has been a year of uncertainty for our profession and the wider business community. The source of much of the uncertainty, Brexit, has now been pushed into 2020 with a flextension which gives a new deadline of 31 January. Members can keep up-to-date in our Brexit web centre while the Institute continues to do all it can to support members and member firms while managing their preparations. New technology-focused FAE curriculum Digital disruption is transforming the business world. The accelerating pace of technological change has kicked off a revolution in financial services.  As an Institute, it’s important that we lead the way. It is part of the role of the accountant to anticipate those changes ahead and to ensure that our client or organisation is not just ready to survive, but to thrive.   That is why we recently announced a new partnership with leading Robotic Process Automation (RPA) software firm UiPath, making us the first professional accountancy body in the world to begin formal training and examination of students in this area. As part of our augmented education programme, more than 1,300 trainees per year will be studying and developing practical skills in artificial intelligence, RPA, blockchain and cryptocurrencies. We believe that it represents an important investment which will benefit our trainees, profession and the wider economy. Together, our member firms are the largest employer of graduates in Ireland. It is vital that we give them the best possible business education. In recent weeks, I was privileged to present certificates to almost 500 new members of our Institute at ceremonies in Belfast, Cork and Dublin. I’d like to congratulate all of our new members (and those who supported them along the way). The Brydon Review  At our AGM in May, I said that the future of audit would be a key consideration during my term in office.  I had the opportunity to discuss the issues with Sir Donald Brydon in October. He is, of course, overseeing the Brydon Review into the quality and effectiveness of audit on behalf of the British Government.  The discussion ranged from the extent to which the future audit reports should inform as well as assure stakeholders, to consideration of how to enhance the audit process by having greater collaboration between audit committees, company management and the auditor.   The meeting was the third element in a series of engagements by the Institute, both in writing and in meetings, with the Brydon review team. Sir Donald Brydon’s report is expected by the middle of January, and we will keep members informed of any developments. IFAC board appointment At the annual IFAC board meeting in Vancouver earlier this month, I was delighted to be present to support the election of an Irish Chartered Accountant to the board of IFAC. Joan Curry, a Council member of Chartered Accountants Ireland and Principal Officer in the Department of Transport, Tourism and Sport, is the first Irish Chartered Accountant to serve on the board of IFAC. Her appointment is a testament to her own immense abilities and to the regard in which your Institute is held by the global standard setting body. Joan’s success was acknowledged by our own Consul General in Vancouver, who hosted a lunch in honour of Joan’s achievement. Annual Dinner Finally, the 2020 Chartered Accountants Annual Dinner will take place in the Convention Centre, Dublin on Friday 31 January. I am delighted that our guest of honour will be Irish Chartered Accountant, businessman and philanthropist Lochlann Quinn. Bookings for the event are now open. I look forward to welcoming friends, colleagues and guests to our premier event at the end of January. Conall O’Halloran President 

Dec 03, 2019
Comment

Brian Keegan considers the poignant parallel between Brexit and New Zealand in the 1970s. "Earthquake? Best thing that ever happened to us.” This isn’t the best response to the damage done to the city of Christchurch in New Zealand in the wake of the terrible earthquake in 2011. My man had the grace to acknowledge as much after he remembered the appalling loss of life and limb from this particular natural disaster. Nevertheless, as someone who was deeply involved in the New Zealand construction industry, he was all too happy to see the opportunities created by the devastation. It isn’t the first time that New Zealanders suffered due to powerful circumstances outside their control. While the memories of the 2011 earthquake are clearly fresher, there is also a folk memory among New Zealanders of the economic damage caused to them when the United Kingdom joined the European Union in 1973. For a country largely dependent on agriculture exports to its former Commonwealth headquarters, the British accession to what was then the European Economic Community some 40 years ago was a disaster. The economic disruption of 40 years ago is comparable to the threatened damage from Brexit to the food industry of Ireland – north and south. In the 1970s, New Zealand’s main exports were butter and lamb. Despite being on the other side of the world, the UK was a key market for these goods and, in fact, accounted for some 30% of New Zealand’s exports. Being members of the Commonwealth, New Zealand had preferential access to UK markets. That access was to be a casualty of Britain’s accession to the EU. In fact, so great was the problem for New Zealand that London committed to doing what it could to protect New Zealand’s vital interests in the course of negotiating the British accession treaty. The so-called Luxembourg agreement guaranteed limited access for New Zealand produce for a five-year transition period. The idea was to give New Zealand breathing space to negotiate free trade deals with other markets and diversify its export offering, but the economy tanked nevertheless. If all this sounds familiar, that may be because we are witnessing history repeating itself in a way that would have considerable entertainment value if the issues weren’t quite so serious. Leo Varadkar’s mischievous remark that Westminster should offer pay-per-view wasn’t that far off the mark. We may, however, be watching the wrong channel if we are to learn from this repeat – it’s the New Zealand experience we should focus on. In the 1970s, New Zealand wine was virtually unobtainable in Europe and kiwi fruits were a rarity. Now they are mainstream. 40 years on, New Zealand’s export destinations are Australia, China, the United States (US) and Japan in order of importance. The country’s volume of trade with the UK has declined by over 60%. Our Brexit discussions must now move on from brinkmanship and dead-in-a-ditch rhetoric. We are going to have to figure out how to co-exist and trade with our nearest neighbours, culturally and geographically. Business will have to work out how to diversify and establish new markets, and hopefully avoid a repeat of the worst aspects of the 1970s suffered in New Zealand. I doubt very much that any of us will ever be exclaiming, however thoughtlessly like my earthquake man, that Brexit was the best thing that ever happened to us. That’s because there’s one other point about the New Zealand experience. Even though it was clear for about a decade that the trading relationship with the UK would inevitably change in 1973, the New Zealanders seem to have done precious little about it until the hammer fell. Sometimes it takes a crisis to deliver change. Dr Brian Keegan is Director of Advocacy & Voice at Chartered Accountants Ireland.

Oct 01, 2019