As Buffett once said, when asked about his criteria for hiring: “The behaviour of the people who run the business is absolutely critical. We look for three things in a person: intelligence, energy and integrity. And if they don’t have the last one, don’t even bother with the first two.”
The implication is that an intelligent and hard-working person can do substantial damage to the business if he lacks integrity, and is untrustworthy, unethical and/or dishonest. For Buffett, integrity is a non-negotiable characteristic. “If someone doesn’t have integrity, you want them to be dumb and lazy.”
Applying this to our investment philosophy, we always seek to invest in companies in which we believe management is capable and has integrity. Management that has integrity is most likely to act in ways that will enhance value for all stakeholders. That includes both the controlling and minority shareholders, employees, customers and suppliers, the community and society at large. Conversely, management that lacks integrity will often engage in self-serving behaviour — for example, paying themselves fat salaries or, worse, defrauding the company — to the detriment of shareholder interests and, in the process, destroys value. Bad management will eventually run even good businesses aground.
For the Malaysian Portfolio, we think United Plantations fits all the criteria for management with integrity. For the Global Portfolio, we could not think of a better company that stands out in this respect than Berkshire Hathaway, the conglomerate led by Buffett and the late Charlie Munger.
See also: Trump’s ‘big’ blunder — and no, it is not tariff per se
Munger once said: “Trustworthiness and soundness of mind are essential to longer-term growth.” He has often stressed the importance of integrity in building trust and reputation as the most valuable asset — and a competitive advantage. Companies that have built trust and unassailable reputations will have better growth prospects.
In other words, good corporate governance is good for business. Leaders with high integrity will foster a positive corporate culture that often translates into higher employee morale and productivity, lower worker turnover and disruptive behaviour. As the Chinese saying goes, “When the upper beam is not straight, the lower beams will be crooked.” Suppliers and customers will have greater confidence when dealing with the company.
Investors would also be more willing to accord well-reputed stocks higher valuations, when they do not have to constantly worry over management decisions that would end up destroying shareholder value. Conversely, when governance risks are high, investors usually demand a deep discount as compensation.
See also: Trump's big blunder - and no, its not tariff per se
Integrity is not inherent or pre-destined — it is a choice, evident from each decision-making. This means that trust is earned based on track record over time. And this track record will be reflected in the stock price, especially over the long term.
Every time we made a mistake in assessing the integrity of management, we have paid for it dearly. As minority shareholders, integrity is all the more important because we lack control over most of the decisions that are made. The risk of poor governance rises when the controlling shareholders are also those in key management positions. And there are near-zero options for minority shareholders to boot out bad management.
In the US, activist investors play a significant role as a check and balance against poor management and are the driving force in unlocking and improving shareholder returns. The absence of activist investors in Malaysia and Singapore means there is little impetus for local companies to actively improve their valuations. Or worse, minority shareholders are often powerless to stop actions that destroy value, especially when management is supported by the controlling shareholders.
This is why there is a higher percentage of companies trading persistently below their book values on Bursa Malaysia and the Singapore Exchange . Many have stayed “undervalued” for years. There is in fact a rational reason (higher governance risks and/or low expected returns) for this seemingly irrational market behaviour (persistent undervaluation). And this is a major issue for both exchanges, affecting their appeal to global investors.
When companies do not make maximising returns for minority shareholders their primary focus — for instance, by using capital inefficiently or ineffectively — it makes their stocks unattractive to investors. The resulting low valuations contribute to a negative perception of the broader market, for both investors and prospective new listings. This then leads to low liquidity and fewer quality companies to attract capital flows, which goes on to perpetuate a vicious cycle.
Insas is one such case. The stock is shaping up to be our worst investment since the Malaysian Portfolio’s inception back in 2014. The company is trading at negative enterprise value (EV) — a phenomenon that is exceptionally rare in US markets — where its market capitalisation (RM641 million at the time of writing) is substantially lower than its net cash of RM1.2 billion.
We had hoped that after years of underperformance — compounded annual total returns (including dividends) of only 3.8% in the past 10 years — management would finally do something to unlock value for minority shareholders. It could — for instance, by distributing excess cash and/or Inari shares to existing shareholders — but has chosen not to.
For more stories about where money flows, click here for Capital Section
Despite the rising cash pile (see Chart 1), the company is not returning excess cash to shareholders — it paid just RM13 million a year in dividends from FY2019 to FY2021 and RM17 million annually from FY2022 to FY2024. That is a fraction of its cash. Instead, Insas is content to sit on its growing cash hoard (now totalling RM1.2 billion, of which only RM31 million is restricted from use/pledged), not working it effectively, and is generating only marginally better than fixed deposit returns.
As a result, the market is pricing Insas at only 0.25 times its book value and a huge 78% discount to our estimated breakup value of nearly RM3 billion (see Table). We can only presume that management has objectives other than maximising value for all shareholders. In other words, there is a lack of integrity. Its stock has far underperformed — even though its underlying businesses have been doing relatively well. The company was profitable every year in the past decade (see Chart 2).
The proof of the pudding is in the eating
Charts 3 to 5 show the huge divergence between the long-term total returns for investors in United Plantations and Berkshire (companies with strong management integrity and that are focused on maximising shareholder value) and that of Insas, as well as the stocks’ performances compared with their respective market benchmarks. Poor governance and management capability as well as unwillingness to improve returns for minority shareholders are reflected in the consistently low valuations of Insas (see Chart 6).
The Malaysian Portfolio gained 1.2% for the week ended Dec 4, outperforming the benchmark FBM KLCI which gained 0.6%. Prices for Insas Bhd – Warrants C rebounded, rising 14.3% and recouping some lost ground. United Plantations (+5.2%) and IOI Properties Group (+5.0%) were other notable gainers. Meanwhile, the biggest losers were Harbour-Link Group (-3.8%), Kumpulan Kitacon (-2.0%) and KSL Holdings (-1.1%). Last week’s gains boosted total portfolio returns to 207.4% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 11.8% over the same period, by some distance.
The Absolute Returns Portfolio also ended higher for the week under review, gaining 2.3% and lifting total returns since inception to an all-time high of 21%. Last week’s gains were led by Palantir Technologies (+5.8%), CrowdStrike (+4.8%) and DBS Group Holdings (+4.5%). On the other hand, shares in Berkshire Hathaway (-3.1%) and Swire Properties (-2%) finished lower.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
