Many institutional investors ostensibly support the idea of focusing on long-term horizons. “Short-termism” suggests speculation, with exposure to the randomness of volatile markets. For institutions, the investors’ dilemma is that their obligations are long term but regulatory and behavioral pressures increasingly exert short-term influences on their decisions. Institutional funds and their investment managers are stewards of the capital entrusted to them, with liabilities that may have a multi-decade or even a multi-generational time horizon. They must maintain a long-term perspective.
Investment Leaders Make a Stand
While the notion of long-term investing may sound compelling, in practice implementation has proved tough. The good news over the past decade is that some of the world’s largest institutional investors have begun to coordinate to promote the concept of long-term investing, and to find ways to resist short-term influences.
In this article we highlight four developments in 2016 that may be catalysts to broaden this movement to the rest of the institutional investment industry. Alone, these four may not change the world (or even the investment industry) but they do provide increasing evidence of industry leadership moving back towards “long-termism.” And if enough institutions and managers support these initiatives, then we believe there is a chance for genuine change – over the long term of course.
Four New Developments in 2016
- In early 2016, S&P announced a new index, the Long-Term Value Creation (“LTVC”) Global Index. According to a press release from S&P Dow Jones Indices, the index measures companies “that have the potential to create long-term value based on sustainability criteria and financial quality.” Six of the world’s largest institutional investors2 have voiced support and pledged $2 billion in aggregate to funds tracking the LTVC Index. These institutional investors are putting serious money into an agreed, unified approach. Institutional investors worldwide may want to pay attention to this initiative.The LTVC Index itself is intriguing. While an index, it has signi cant active exposure relative to the widely used MSCI ACWI global benchmark (Active Share of 79 relative to the MSCI ACWI). Although it includes a sustainability measure, it’s not a conventional ESG (“Environmental, Social and Governance”) approach. For example, as of March 31, 2016, three of the top 20 constituents are tobacco stocks. Country and sector weights are materially di erent from market cap benchmarks: fewer financials, less N. America and more Europe and emerging markets (“EM”). In fact, four of the five largest non-U.S. constituents are EM stocks. For a more detailed assessment, please see the Appendix.
2. Legislators face a true dilemma regarding how pension liabilities are treated in nancial statements. Historically, actuarial valuations have used a long-term horizon in assessing a fund’s ability to meet its liabilities. However, the size of some plan de cits, lower bond yields (hence higher liabilities), and periodic nancial crises have led regulators to focus on how to mitigate systematic risk in the pension system, leading to increased use of mandatory mark-to-market valuations, especially in the U.S. and Canadian private pension sectors. For institutions the impact is to shorten investment time horizons to avoid breaching a mark-to-market solvency test. For legislators the dilemma is that enforcing mark-to-market can reduce the short-term risk of plan failure (by forcing sponsors to contribute more), but at the expense of industry viability, as plan sponsors close their de ned benefit (“DB”) plans as too expensive to maintain.
In Canada, 2016 has seen the rst reversal of this short-termism trend. e province of Quebec passed a bill eliminating its pension mark-to-market solvency test, e ective January 1, 2016, replacing it with a long-term “going concern” test. It’s possible this will give Quebec a competitive advantage with sponsors regarding their DB plans. Not to be le too far behind, Ontario announced it is expediting its study of a similar measure. If both these large provinces move away from mark-to-market, others may need to consider this seriously, as well.
3. For more than 30 years, Keith Ambachtsheer has been a pioneer and thought leader in the global pension industry. His new book The Future of Pension Management brings together ideas and examples of how the industry can solve the key issue for pensions: how to balance a ordability (to sponsors and participants) with the security of lifetime retirement income. His central theme contends all the necessary tools already exist to solve the industry’s challenges; the greatest current need is implementation.
The book showcases the innovative approaches at selected leading global funds. e United States has lagged in this field, and we urge U.S. plan sponsors to read the book. In particular, we would emphasize three of Ambachtsheer’s ideas that tie into the theme of the “Investors’ Dilemma:”
- Neither DB nor De ned Contribution (“DC”) structures solve the a ordability/ security problem in the long term; instead, Ambachtsheer suggests looking to designs for risk-sharing between sponsor and participant3 (known as “de ned ambition” in Europe or “target bene t” in North America).
- Nobel Prize-winning economist Jan Tinbergen suggests the number of policy instruments needed must equal the number of policy goals. In the pensions context, this means that the two goals of a ordability and lifetime income security require two di erent policy instruments. Currently the industry (especially in the United States) continues to move toward using just one (the DC plan as wealth accumulator), so a separate policy instrument is needed to address the post-retirement need for lifetime income.
- Learn from the world’s leading investment organizations. Despite di erences in regulatory regimes, the concepts and issues are similar. Pension funds must align their goals, investment beliefs, organization and culture to succeed in the long term.
4. The lead in long-term initiatives has been taken primarily by the asset owners, the large institutional investors. Asset managers may have supported the ideas, but had taken a back seat in visibility. But on February 1, 2016, the Financial Times story, “Top U.S. financial groups hold secret summits on long-termism” revealed that CEOs of some of the world’s largest asset managers had been meeting to develop proposals for governance of public companies aimed at encouraging longer-term investment. is initiative was reportedly convened by Warren Buffett (Trades, Portfolio) (Berkshire-Hathaway) and Jamie Dimon (JPMorgan Chase), with CEO participants from BlackRock, Fidelity, Vanguard and Capital Group. According to the article, “The asset managers hope to come up with a list of best practices that they will support at the companies they invest in” within several months.
Conclusion
Pressures towards short-term investing have been mounting, and will continue. But recently, we have seen wiser heads prevailing. Leadership of the pension and investment industry is promoting genuine long-term concepts. The tools are all there. The leaders are already moving. Pension fund trustees/administrators, their consultants and asset managers can make a genuine difference in resolving the investors’ dilemma, both for themselves and for the investment industry. It’s time to step up.
The information provided in this material should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any security transactions, holdings or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein. International and emerging markets investing is subject to certain risks such as currency fluctuation and social and political changes; such risks may result in greater share price volatility. Strategies discussed herein are subject to change at any time by the investment manager in its discretion due to market conditions or opportunities. Please note that all indices are unmanaged and are not available for direct investment.
