Carmignac shows faith in family business mindset as key to growth

Hermès International and Cintas Corporation operate at either end of the sartorial spectrum. The French luxury group is globally renowned for the silk scarves, high-end jewellery and €10,000-plus Birkin bags it sells to well-heeled customers. Cincinnati-headquartered Cintas, meanwhile, makes functional products, such as uniforms, mats and mops, that it supplies to businesses.

But despite these contrasts, the companies also have much in common. Both were set up by entrepreneurial founders whose descendants retain sizeable ownership stakes. And they are the two best-performing investments this year in the Carmignac Portfolio Family Governed fund.

The fund was launched just over three years ago by French asset manager Carmignac, itself a family business that was set up by investor Edouard Carmignac in 1989. It is run by Mark Denham, head of European equities, and portfolio manager Obe Ejikeme.

“Carmignac is a family-governed business and we’re aware that, sometimes, in order to make the best long-term strategic decision, you have to go against [consensus] thinking on a short-term basis,” says Denham. “You have to be prepared to make those long-term decisions.”

Long-term thinking, an entrepreneurial mindset and shared culture are three qualitative reasons that make investing in family businesses appealing, the fund’s managers believe. When they explored launching a strategy around this philosophy, they sought empirical evidence to support their thesis. Their analysis of the returns of about 500 companies between 2004 and 2019 revealed that family businesses outperformed the MSCI World index by an average of 1.7 per cent a year. These companies were typically more profitable, both in terms of return on equity and return on invested capital and, with owner families’ skin in the game, they used less debt.

“Family businesses were more profitable than non-family businesses almost every year,” says Ejikeme. Their tendency not to use debt to finance their growth is another draw in a world of rising interest rates, he adds.

This echoes findings in other research and it has led financial services companies such as Pictet of Switzerland and the Franco-German Oddo BHF to offer funds that invest in family businesses.

A 2018 report by Credit Suisse also found that family companies — where founders or descendants hold at least 20 per cent in direct shares, or their voting rights are at least 20 per cent — tend to outperform their non-family peers with stronger top-line growth, better profitability and more conservative balance sheets. Their longer-term investment focus helps them to look beyond quarterly earnings announcements and invest for the long term, the report said.

The Carmignac team constructs its portfolio using criteria that whittle down the universe of 700 or so family businesses to 35-40 positions, primarily in mid- to large-cap stocks. As a first port of call, they look for the governing influence of a family, founder or foundation with at least 10 per cent of the shareholder voting rights. “Voting rights are more important than size of ownership,” says Ejikeme.

Liquidity is another important consideration: the fund managers look for stocks that have an average daily trading volume of at least $25mn. Other criteria include profitability, earnings reinvestment and the quality of a company’s governance. While 62 per cent of the universe of 700 family companies are based in emerging markets, many of these don’t meet the criteria for profitability or governance. The managers end up with a choice of about 150 companies globally that satisfy all the criteria.

Governance matters where families are involved, argues Denham. “It’s all very well investing in family-controlled companies, but there’s a risk as a minority shareholder that you get taken in a different direction against your wishes,” he says. “It’s very important that we make sure there are proper controls and structures in place to protect minority shareholders and that, in practice, the family or foundation control is used in a benevolent way for the benefit of all shareholders.”

Carmignac has its own experience of how having a family shareholder does not leave a company immune to trouble. Its overall assets have fallen from €57bn at its peak in 2017 to €33.2bn today, and its flagship Patrimoine fund has underperformed its benchmark over the past five years. Founder Edouard Carmignac stepped back from day-to-day management of Patrimoine in 2019 but remains chairman and chief investment officer.

While corporate governance risks, such as a lack of succession planning or overly long-serving board members, are a key consideration, even more important are “corporate behaviours”, adds Denham. “One clear red flag would be if there were so-called related party transactions between the founder or the family and the company.”

This year, to November 15, the Carmignac Portfolio Family Governed fund is down 15.1 per cent, underperforming its benchmark, MSCI’s flagship equities ACWI index, which has lost 8.3 per cent in the same period. Since launch, the fund has underperformed the index by about five percentage points.

However, the managers say this underperformance in 2022 is partly because quality stocks (which are highly profitable, have stable cash flows and low debt-to-equity ratio) have underperformed value stocks (those with low price/book and price/earnings ratios) this year, and the universe of family companies is weighted more to the former.

“In years like 2022, when quality companies have lagged the general market returns, that can create a short-term headwind to performance,” says Denham. This year, the energy, materials, industrial and banking sectors have outperformed, and they count fewer family companies among them.

It’s very important there are proper controls and structures in place to protect minority shareholders

Half of the portfolio’s top-10 shareholdings are in healthcare. These include US group Eli Lilly, of which Lilly Endowment, a private foundation, owns just over 10 per cent, and Denmark’s Novo Nordisk, just over 30 per cent of whose shares are owned by the Novo Holding foundation.

The Carmignac portfolio has a low turnover and will typically change five investments over the course of 12 months. When the voting rights of Pieter van der Does, founder of payments company Adyen, fell below 10 per cent, the fund sold its position. Similarly, when a general review highlighted “inadequate oversight of the accounting process” at a US industrial company, they divested.

The Carmignac Portfolio Family Governed fund runs €30mn and has just passed its three-year track record, an important criterion for fundraising. “Until you have a three-year track record, no one wants to consider the concept,” says Denham.

This article is part of FT Wealth, a section providing in-depth coverage of philanthropy, entrepreneurs, family offices, as well as alternative and impact investment