"The world would be a better place if businesses stopped thinking so much about short-term results and focused more on the long term," wrote Adi Ignatius, editor of the Harvard Business Review, in January 2014. The same is sometimes said of asset managers and the investors they serve. A longer-term approach to investment can lead to improved longer-term decision-making by companies, in turn resulting in better long-term performance and better alignment between asset owners’ liabilities and assets. But how can we achieve this?
In a world where so many of the interactions we make in our personal and professional lives are so immediate, it’s no surprise that businesses’ timeframes have been shortening.
Innovation, and the ability to use technology in a data-led marketplace, has inevitably enabled short-term participants to exercise greater sway over, for example, trading patterns. The increasing trading volumes of high frequency traders, the incentive structures and strategies of activist investors, restrictions on portfolio allocations driven by regulatory change, and mounting pressure on short-term performance by asset managers have all led to an increasing, collective myopia, evidenced by steadily decreasing holding periods.
While a short-term horizon is the very essence of some activity, it can have negative consequences, including the distortion of prices and asset correlations, the reduction of wealth through churning, and the undermining of potential long-term value creation for clients.
Asset managers, given their key role in the allocation of capital, have a vital part to play in addressing this. They should fulfil the critical function of encouraging markets to take a longer-term view and encouraging investee companies to have sustainable business models.
In 2010, the Financial Reporting Council published the first UK Stewardship Code. Directed at institutional investors, it set out the key principles of effective stewardship, which would help promote the long-term success of investee companies in such a way that the providers of capital also benefit. Five years on, almost 300 organisations have publicly signed-up, including more than 200 asset managers who represent 32 per cent of the UK equity market.
The take-up of the Code is an encouraging step forward in building a mass of investors willing and able to engage in active stewardship. But the quality of engagement is still, at least perceived to be, too low and some signatories appear not to be following through on their commitment to the Code, perhaps seeing it as a box ticking exercise. Asset managers must engage further in their role as stewards of capital.
Over past decades, there has also been a seemingly inescapable shift towards quarterly reporting by companies. To its credit, the FCA abandoned its quarterly reporting rule in a move to encourage longer-term thinking in stock markets. But only a handful of firms have so far begun to review the frequency of their reporting. Asset managers must proactively show support for those companies brave enough to implement such changes.
Further, policymakers and regulators must address regulatory barriers and other obstacles that hinder a longer-term perspective, such as accounting treatments of assets, and propose guidelines to promote long-term horizons in governance and portfolio management. Here, the private sector can contribute ideas on new models. A recent example is the work carried out by the Cambridge Institute for Sustainability Leadership on long-term responsible investment in the context of mandates.
To achieve real change, however, the roles and approaches of all stakeholders in the investment chain need to be considered. Consultants, for instance, should be encouraged to take a longer-term view and question fund turnover and agency effects to a greater extent. Some do, but it is not yet common practice. Incentive schemes across the industry must better align rewards with the long-term goals of clients.
In addition, while not all asset managers will have sufficient resources to do so, more should be done to engage with investee firms on their governance, and ensure the right skills and teams are brought together to achieve the responsible mandates asset managers are being encouraged to use.
The economic imperative for action is clear. Low levels of long-term capital investment in the UK contribute to low workforce pay and hinder productivity, one of the greatest drags on the British economy. If government, business and finance are able, collaboratively, to create a culture where the long-term stewardship of assets is celebrated, with investors and investee companies recognising their shared interest in long-term success, the potential economic benefits are great.
The good news is that work to this end is already underway, with institutional investors and policymakers clear that long-term capital is an important pillar of long-term competitiveness. Working together, we can shape an investment environment built on the sound economic and social foundations of sustainable, long-term investing.