Counting the cost of corporate scandals – what are they and how to avoid them

Avoiding companies with corrupt practices is one of our investors most important environmental, social and governance (ESG) related priorities*. And it’s easy to see why.

History is littered with corporate scandals that have cost unsuspecting investors billions.

Arguably the most infamous was US electricity turned energy trading company Enron. Using a variety of fraudulent accounting techniques, Enron appeared hugely profitable, even on projects that had barely begun. When the misdeeds were made public in 2001, the company collapsed, taking its auditor, Arthur Anderson, with it.

But corporate scandals aren't just consigned to the history books.

As recently as June 2022, energy company Glencore was convicted of a decade-long bribery scheme to secure preferential access to oil and generate illicit profit across operations in several African countries. The resulting fines and financial settlements are expected to top $1.5bn.

Even before the scandal, some investors had concerns about the quality of Glencore’s governance processes. These processes created the potential for unethical behaviour and poor decision making.

*Survey of 766 people by Opinium for HL in March 2023.

How can investors avoid scandal?

Integrating ESG analysis, especially around governance, into your investment decisions is a great way to reduce your chances of being exposed to the risks of a corporate scandal.

If a company is well-managed and managers receive adequate challenge, that reduces the potential to get away with acts of fraud or deceit.

There are a number of questions investors can ask themselves to work out whether a company is well managed. For example:

• Pay – are company managers paid appropriately and in line with the interests of shareholders? Is there proper disclosure on executive pay?
• Scrutiny – do managers receive appropriate scrutiny from an independent board? Is there separation of the chairman and CEO roles? How many independent directors are on the board?
• Accounting – does the company use fair accounting practices? Is it transparent in its approach to taxation?
• Auditor – does the auditor have a positive opinion of the accounts?
• Voting rights – do all shareholders have equal voting rights?

ESG – the easy way?

This week is Good Money Week, a national campaign promoting responsible investing. It’s an ideal time to look at your investments through an ESG lens and identify any vulnerabilities that could leave your investments open to the potential for a future corporate scandal.

For more information on ESG integration and other responsible investing approaches, visit our responsible investment hub.

If you don’t have the time or expertise to carry out ESG analysis for yourself, you could consider a fund which does the heavy lifting for you.

Fund managers also tend to have relatively big stakes in individual companies, meaning they can engage with them to help drive improvements.

Here are two funds we think can do just that.

Investors should remember that while ESG analysis reduces the probability of being exposed to corporate scandal, it can’t eliminate it completely. That's why you should invest in a diverse portfolio with investments in lots of different companies, industries, and countries. This should reduce the overall impact of any one area performing poorly.

This article isn’t personal advice. If you’re not sure an investment is right for you, seek advice. Remember that all investments fall as well as rise in value, so you could get back less than you invest.

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest.

For more details on each fund and its risks, you can use the links to their factsheets and key investor information below.

FSSA Asia Focus

Martin Lau is the lead manager for FSSA Asia Focus. He’s highly regarded and has invested in Asia for more than two decades.

Lau and his team look for quality companies for the long term. They like those with a competitive advantage that others struggle to replicate. Think things like a well-known brand or the ability to raise prices for their products without affecting customer demand.

Their philosophy is founded on stewardship. When they make an investment, they see themselves as part-owners of the business. They engage with companies to make sure they're run in a way that'll benefit all shareholders.

For example, they recently became concerned about protests by ‘gig economy’ workers like food delivery drivers across China. Being neither full-time nor part-time workers, they fell through the cracks in labour laws. As a result, they were paid low wages, worked long working hours and got limited benefits.

Despite their investment in Yum China, a fast-food restaurant chain, not being directly impacted by the protests, the team still reached out to the company’s management to clarify their approach.

The Yum China management team confirmed that delivery drivers are employed full-time and receive all the relevant benefits. Meanwhile part timers are paid competitively and have liability insurance and wellness benefits. Behaviour like this should help to reduce the company’s exposure to labour rights controversies in the future. 

Emerging markets are generally less well-regulated than the UK and it can sometimes be difficult to buy and sell investments in these areas. Political and economic instability are more likely, making these funds higher risk than those investing in more regulated and developed markets. Part or all the annual charge is taken from capital rather than income generated, increasing the potential for your investment’s capital value to be eroded.

More information on FSSA Asia Focus, including charges

FSSA Asia Focus Key Investor Information

Legal & General Future World ESG Developed Index

Legal & General Future World ESG Developed Index invests in more than 1,400 companies worldwide with the aim of tracking the Solactive L&G ESG Developed Markets Index.

The index invests more in companies that score well on a variety of ESG criteria – like the level of carbon emissions generated, the number of women on the board and the quality of executive pay disclosures. If companies score poorly, the index invests less.

Violators of the UN Global Compact (a UN agreement on human rights, the environment, labour and anti-corruption) are excluded, as are companies involved in tobacco and those making controversial weapons (like cluster bombs and anti-personnel mines).

The fund also avoids companies that earn more than 20% of their revenues from thermal coal and oil sands.

The fund’s aiming to reduce emissions by 50% compared to the broader global stock market. It also wants to achieve at least a 7% reduction in carbon emissions per year until 2050.

This fund can invest in smaller companies, which are more volatile and sometimes more difficult to trade than larger companies.

More information on Legal & General Future World ESG Developed Index, including charges

Legal & General Future World ESG Developed Index Key Investor Information

3 responsible fund ideas to future proof your portfolio

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