“What do we really mean when we talk about long horizon investing?”
It was a question one plan sponsor voiced during last week’s meeting of the Canadian Investment Review advisory board where we mulled over the big issue facing plan sponsors in Canada.
The thing is, just a few decades ago, the answer to this question would have been pretty obvious, especially at a time when the name of the game for defined benefit pension funds was long-term investing. And indeed it was truly long-term.
Of course, that was back in the day, when nice, steady long-term bonds provided everything plan sponsors needed to deliver on the pension promise.
Today, for better or for worse, the question, “what does long-term investing mean?” strikes to the heart of the pension industry and the state of global capital markets as a whole.
Are there any truly long-term investors left? And if so where are they?
McKinsey’s Dominic Barton and the Canada Pension Plan’s Mark Wiseman ask the same question in a new paper called Focusing Capital on the Long-Term. To get the discussion started, they list a few incredibly depressing survey results from McKinsey that illustrate just how near-sighted executives and board members of the world’s biggest companies have become. Out of 1000 corporate leaders surveyed,
• 63% said the pressure to generate strong short-term results had increased over the previous five years.
• 79% felt especially pressured to demonstrate strong financial performance over a period of just two years or less.
• 44% said they use a time horizon of less than three years in setting strategy.
• 73% said they should use a time horizon of more than three years.
• 86% declared that using a longer time horizon to make business decisions would positively affect corporate performance in a number of ways, including strengthening financial returns and increasing innovation.
The reason for such short-term thinking? Pressure from investors.
The solution, according to Barton and Wiseman: Large asset owners need to act more like…well, asset owners.
Here’s what they say about the world’s biggest asset owners (i.e., pension funds, mutual funds, sovereign wealth funds and insurers)
… Too many of these major players are not taking a long-term approach in public markets. They are failing to engage with corporate leaders to shape the company’s long-range course. They are using short- term investment strategies designed to track closely with benchmark indexes like the MSCI World Index. And they are letting their investment consultants pick external asset managers who focus mostly on short-term returns. To put it bluntly, they are not acting like owners.
Unless asset owners change their behavior, then, we’ll be stuck in the “tyranny of short-termism” and corporate strategies that don’t contribute to the long-term well being of the global economy.
It’s a powerful argument – but what can investors do to fix the problems?
Barton and Wiseman offer a four-step approach:
1. Define long-term objectives and risk appetite, and invest accordingly.
2. Practice engagement and active ownership
3. Demand long-term metrics from companies to inform investment decisions.
4. Structure institutional governance to support a long-term outlook.
Until that happens, more and more companies will have to fly under the radar screen, pushing away from public markets and looking to private equity to generate real long-term performance and meaningful growth.
For plan sponsors with truly long-term promises to keep, the question of what makes a long-term investor should be top of mind in the decade ahead.
Indeed, the survival of public equity markets depends on getting the answer right.