What makes a good management team?

Every active fund manager will tell you about the importance of a good management team when investing in a company, and this is arguably even more important when running a special situations strategy.

We class a ‘special situation’ as a good company that has fallen out of favour with the market but that has the potential to return to its former glory. Often it is the arrival of a new management team that is the catalyst for a recovery.

But how can you tell if a management team will turn the business around or hasten its downfall? After all, no board of directors is going to hire someone to run its company unless it thinks they are up to the job.

In our experience, it comes down to separating those who are capable of spinning a good story from those who are capable of delivering on it.

The signs we look for in a good management team:

Strong track record

It may sound obvious when we say we look for incoming management teams with a strong track record. But establishing who has ‘form’ involves more than looking at their last company’s set of accounts.

When we see a management team turning a business around, we sit up and take notice – even if we don’t intend to invest with them. There have been occasions when management teams who we met 10 years ago pitch up at a company we have been monitoring, so we immediately know what sort of processes they will introduce.

You can’t keep tabs on every half-decent management team. This is why you need an extensive network of contacts. In this way, if you don’t know the new chief executive personally, you can normally ring up someone who does.

A conservative approach

We prefer management teams that are quite considered rather than those that are overly promotional. We've seen instances in the past where management teams that have recently entered a new industry have made major deals straight off the bat. That puts us off.

When a new chief executive or finance director joins a company that we are interested in, we will ask for a frank diagnosis of the business: we like teams that provide a balanced outlook showing they are cognisant of both the opportunities and threats, rather than those who are only focused on the upside.

A good example is defence company Babcock, which had become over-levered due to a series of poor acquisitions.

After joining in 2020, the new management team made £1.7 billion of negative adjustments to the balance sheet¹. These included contract write-offs and the impairment of operating assets.

Such actions don’t usually scream ‘investment opportunity’. However, our interest was piqued when the company announced it wouldn’t need to raise equity – this was significant as the new chief financial officer had a reputation for conservatism. Instead, it raised £400 million from disposals to pay off debt, while shedding significant liabilities that went with these businesses.

This is what finally convinced us to invest, at about 300p² a share; it also helps to explain why we see further upside from Babcock’s current price of about 500p³. The same management team recently announced targets for higher organic revenue growth and margins than forecast by the market, underpinned by a cash-conversion target.

Time to prove themselves

It doesn’t matter how strong a management team’s track record is – when they enter a new business, it requires a leap of faith among investors. Remember, what works well in one business or industry doesn’t automatically work well in another.

As a result, we invest modestly during the early stages of a company’s rehabilitation stage – say about 1% of AUM – then wait for signs of incremental improvement to show that management is delivering what it said it would.

It may not happen in lockstep. But if you can see evidence of operational momentum such as completed disposals, margin expansion or revenue acceleration, that gives us the confidence to increase our investment to a more meaningful position.

This is why we invest in businesses with solid balance sheets and strong cashflows – these afford management the luxury of time.

A focus on more than just numbers

Our aim is to buy into businesses that are capable of increasing earnings, as valuations are never too far behind.

But the manner of profit increases can be just as important as their scale. Simply cutting costs can be a false economy – while this can provide a short-term boost to profits, more fundamental changes and investment are often required to put the business on a sustainable path to recovery.

A lot of the time it comes down to culture. When we first invested in Tesco, it had financial problems, but it also had problems with its supply chain and staff engagement. In a retail business, customers can tell when the store is under resourced, with gaps on the shelves and longer queues. A management team that prioritises fixing these issues will bring stability to the business, giving investors confidence and meaning it is more likely to be rewarded for improved resilience once finances are back on track.

Modesty

You don’t want to invest behind someone who is scared of making difficult decisions, but the opposite characteristic can be just as damaging.

One of the key questions we ask ourselves is “will bad news travel in this organisation?” This is because if a company has an aggressive chief executive who overpowers the rest of the management team, they may be scared to tell them if things go wrong, meaning problems don’t get dealt with and are allowed to get worse.

As a result, we are always on the lookout for certain nuances in the way the chief executive interacts with the rest of the team – do they constantly cut in? Do they try to dominate every conversation? Do they offer access and showcase the wider management team? This is why there is no substitute for regular meetings.

Alignment of interests

Incentives are a key driver of human behaviour, but when we talk about ‘alignment of interests’ we mean more than just remuneration.

It helps when management teams have ‘skin in the game’, or a significant proportion of their wealth tied up in the company. But perhaps even more important is when they feel their reputation is on the line.

For example, we first invested in Jet2 during Covid. It’s difficult to think of anything worse for an airline than not being able to get passengers onto a plane, which is why its share price fell by 75% in a matter of weeks⁴.

However, we invested alongside a founder shareholder who didn’t panic or make any knee-jerk decisions. Instead, he ensured the company took care of its hoteliers and workforce and refunded customers on time.

This gave us the confidence it had the staff and infrastructure in place to get the business up and running quickly once it was allowed to reopen. And this is exactly what happened.

Ultimately, it is these intangibles that move an organisation. It doesn’t matter how big a business is, if a chief executive has the right combination of skills, they can motivate tens of thousands of employees to go above and beyond for them. In our experience, investors will eventually follow.