Why family-owned companies tend to outperform

Are the management of the businesses you invest in correctly incentivised to run it effectively? If their remuneration effectively offers rewards for failure, that doesn’t bode well. If their pay package is overly linked to short-term results that can be just as damaging in the long run.

Ideally the interests of managers and investors should be aligned and focused upon creating durable, long-term value for all the owners of the company. Managers who expect to retire, or get lured away by head-hunters can lack commitment. But when their personal wealth is tied up in the business, their interests and those of outside investors are more likely to align.

There are fund managers out there who have given their funds an edge by insisting on only investing in stocks where management are significant owners of the companies they run. Anthony Cross and Julian Fosh, managers of the Liontrust Special Situations Fund, for example, will only invest in smaller firms if management own at least 3% of the company. Some invest mainly in family-controlled companies; an example being Richard Pease, manager of the FP CRUX European Special Situations Fund. When management have serious skin in the game, the argument goes, they will be more committed, in every aspect of how they run their business.

Expenses will be more tightly controlled, and a manager whose own wealth, and perhaps their wider families’ wealth, depends on the success of the business for generations to come, is unlikely to be distracted by short-term targets at the expense of the bigger prize. Crucially, risk taking will be more measured. Rich people do not like the idea of waking up poor.

Do the results bear out?

We’ve analysed the performance of all the constituents in the FTSE All Share index and the AIM All Share index and compared the performance of companies where insiders own 5% or more of the shares, against those where insider ownership is less than that. It did not matter whether we looked at small, medium or larger companies; over the longer term, companies with high levels of insider ownership tended to outperform by a big margin.

Insider ownership versus total return for FTSE All Share Index

Past performance is not a guide to future returns.

Source: Bloomberg, 9 October 2015

In the case of the AIM companies, the difference was especially striking. Over ten years, AIM companies with 5% or greater insider ownership delivered average total returns of over 200%, whilst the rest of the AIM market delivered a small negative outcome.

Insider ownership versus total return for FTSE AIM Index

Past performance is not a guide to future returns.

Source: Bloomberg, 9 October 2015

How could investors benefit?

As always with investing, there are no guarantees. One of the more notorious failures was Robert Maxwell and his ill-fated Mirror Group and there are numerous less dramatic examples. But if the people running the companies you invest in are really focused on making the business succeed, year in, year out, that has to be a good starting point.

We’ve put together a list below of companies with significant family influence, where we can see a strong track record and promising future prospects. Some are FTSE 100 members, others are drawn from the mid cap universes and AIM.

Past performance is not a guide to future returns.

Source: Bloomberg and Lipper IM, 9 October 2015