How ‘Agile Allocators’ Increase Long-Term Value

While allocating capital is one of the CFO’s most important performance responsibilities, many companies still approach it as a pro forma exercise. They vary little in the proportion of capital deployed in different categories, such as organic investments, mergers and acquisitions, and returns to shareholders each year.

Especially during a market recovery, and with a clearer view of future cash flows, now is the time to be an “agile allocator”.

Agile allocators aggressively move capital to high-return opportunities, rather than sticking to fixed allocations each year, to meet long-term strategic goals and increase Total Shareholder Return (TSR). For example, these companies are more willing to consider mergers and acquisitions when market prices are low or invest more in innovation than in capital expenditure expansion (CapEx) for a declining product.

So why aren’t more companies nimble dispatchers? One obvious reason is organizational inertia. But another is that many companies do not have an individual responsible for the assessment. investment opportunities on an equal footing. This can lead, for example, to budgeting for research and development (R&D) based on a benchmark, such as a percentage of revenue, rather than evaluating the investment against other opportunities. .

Agile allocators can generate excess returns

A recent EY analysis of nearly 1,000 corporate capital allocation strategies shows that agile allocators can generate excess returns for shareholders. We analyzed TSR data¹ over three distinct periods: 2008 to 2011, 2012 to 2015 and 2016 to 2019. Although there was no significant difference during the global financial crisis, Agile dispatchers generated a median TSR of 60% from 2012 to 2015 and 49% from 2016 to 2019. These returns exceeded the TSR of the passive allocators over the same periods by 35% and 43%, respectively.

Agile allocators can reap disproportionate returns as they quickly move capital at key times to seize market opportunities. This may include investing in attractive adjacencies, such as a sportswear manufacturer entering the golf equipment market.

Surplus returns by sector

Sector dynamics can impact the benefits of the agile allocator. In the same analysis², we noted that agile dispatchers have driven higher TSR in the consumer, healthcare and tech sectors by adapting to the dynamics of the rapidly changing industry. In the tech industry, for example, agile dispatchers outperformed passive dispatchers by 32% and 14% in median TSR from 2012 to 2015 and 2016 to 2019, respectively. One semiconductor company, for example, aggressively shifted its capital from CapEx to R&D and M&A and thus saw a substantial increase in TSR.

However, agile dispatchers in manufacturing and energy did not significantly outperform passive dispatchers. One of the potential reasons for this is that these sectors tend to invest much more in CapEx than other industries given their asset profiles. – which could reduce the benefits of reassignment. Sufficient data to analyze this in depth is not publicly available, but we suspect that companies that practice more agile allocation in their CapEx investments would be also tend to outperform. Another potential reason is that investors have focused more on broader structural changes in these industries, such as the emergence of electric vehicles in manufacturing and the impact of climate change in the energy sector. Shareholders can give more weight to this broader sector dynamic – at least recently – than to examine the results of the capital allocation.

Median TSR by sector, agile vs passive allocators

(Note: Agile dispatchers are defined as companies with a standard deviation of capital expenditure, research and development, or mergers and acquisitions greater than 25% from 2008 to 2019.)

Key steps to be an agile allocator

Becoming an agile allocator takes more than just moving the budget every year. Good capital distributors can follow several steps:

• Appoint a manager responsible for the agile allocation of capital: This person must develop, refine and monitor a rigorous and comprehensive process – and have visibility into all potential uses of capital. This person should also provide the CFO with timely information to challenge and reward the investment decisions of business leaders, as well as to make informed and impartial judgments when necessary.
• Evaluate investment options on an equal footing: Using common metrics and key performance indicators when evaluating different types of investments can increase speed and confidence in decisions to move capital – especially from one type of investment to another.
• Sensitize stakeholders to agile allocation: Switching from a static allocation can be shocking for some stakeholders who are used to seeing a specific percentage each year. Shareholders and other stakeholders are more likely to react favorably when they see how a capital allocation decision fits into the strategy for long-term value creation.
• Monitor investments more actively: This process should include the relationship between budget and actual data, as well as the review of forecasts and business plans. A change in the outlook for the project may require a course correction to achieve expected returns or a complete shutdown of the project. Many businesses are unwilling to “fail quickly” – more active monitoring may argue in favor of redeployment.
• Perform the post–mortem reviews: Review the results of capital allocation decisions and adapt the process in the future to support more efficient decision-making.

Conclusion

CFOs must now steer their businesses towards an agile capital allocation in order to capitalize on changes across all industries and outperform their peers. Strategic reallocation of capital to areas that generate long-term value, rather than a static process that places the same percentages in the same compartments every year, can help increase TSR.

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Dave poniatowski is Director, Strategy and Transactions, Ernst & Young LLP. Loren B. Garruto is the Head of Corporate Finance and Transactions for the Americas, Ernst & Young LLP.

The views expressed in this article are those of the author and do not necessarily reflect those of Ernst & Young LLP or other members of the global EY organization.

1. Capital QI 2008-2019
2. Same