Focusing Capital on the Long Term: A Call to Action. Sarah Keohane Williamson, CAIA, CFA Brisbane 14 March 2018

Transcription

1 Focusing Capital on the Long Term: A Call to Action Sarah Keohane Williamson, CAIA, CFA Brisbane 14 March 2018

2 Long term success requires long term thinking from asset owners, asset managers and corporations 1 Effective long-term capital allocation is fundamental for innovating and creating value, but short-termism is pervasive and costly to companies and society. 2 FCLTGlobal is an independent not-for-profit organization supported by 37 asset owners, asset managers and corporations globally. 3 Our goal is to drive action through developing practical tools to combat short-termism and rebalance towards effective long-term capital allocation across the investment value chain. 2

3 Long-term goals often get lost in the investment process Savers typically have long-term goals such as retirement or providing for the next generation Companies typically make multi-year investments in new markets, facilities or products The incentives, habits and behaviors in our capital allocation process can turn these long-term goals into short-term decisions Savers Asset owners Asset managers Corporate boards Management Communities Policymakers, regulators and other stakeholders 3

4 Short-term pressures continue to inhibit longterm value creating behavior 87% of executives and directors feel most performance pressure over 2 years or less 55% of CFOs would delay NPV-positive projects to hit quarterly earnings targets 101% of 2016 earnings for S&P 500 companies spent on dividends and buybacks 86% of executives agree longer time horizons for business decisions would improve performance SOURCE: McKinsey Quarterly Survey, 2016; McKinsey analysis, S&P 4

5 Long-term companies exhibit significantly stronger financial performance and job creation Long-term companies, as defined by five financial metrics, outperform shortterm companies over time (capex/depreciation, accruals/revenue, margin growth, EPS vs. earnings growth, and narrowly missing EPS targets) During the financial crisis, long-term companies were punished by the market but bounced back stronger If the short-term term companies had been able to match the performance of the long-term companies, the US would have created five million jobs and added $1 trillion in asset wealth over this time 5

6 Long-term investors earn superior returns through a long-term premium Thinking Ahead Institute Willis Towers Watson: The Search for a Long-term Premium We strongly believe that a long-term premium exists and can be meaningful depending on implementation. The costs of developing the mindset and acquiring the skillsets to address long-horizon investing challenges are substantially outweighed by the return enhancements. It is reasonable for investors to expect a net long-term premium of 0.5% to 1.5% pa, depending on their size and governance arrangements. 6

7 FCLTGlobal is supported by leading asset owners, asset managers and corporations worldwide Members as of 1 January

8 Board of Directors and Strategic Advisors Dominic Barton Global Managing Partner, McKinsey & Company Else Bos Former CEO, PGGM Natarajan Chandrasekaran Chairman, Tata Sons Larry Fink Chairman and CEO, BlackRock Chow-Kiat Lim CEO, GIC Andrew N. Liveris Chairman and CEO, The Dow Chemical Company Executive Chairman, DowDuPont Board Member Nitin Nohria Dean, Harvard Business School Board Member Board Member Strategic Advisor Strategic Advisor Board Member Strategic Advisor Mark Machin President and CEO, Canada Pension Plan Investment Board Paul Polman CEO, Unilever Randall L. Stephenson Chairman and CEO, AT&T Inc. Mark A. Weinberger Global Chairman & CEO, EY Theresa J. Whitmarsh Executive Director, WSIB Sarah Keohane Williamson CEO, FCLTGlobal Board Member Board Member Strategic Advisor Board Member Board Member Board Member ex-officio Mark D. Wiseman Global Head of Active Equities and Chairman of Alternative Investors, BlackRock Board Chair 8

9 Our research addresses short-term behavior across the investment value chain Approach Key Questions Evidence-based: Building on academic and internal research Practical: Developed with members for market participants Global: Feasible within most current regulatory environments Cross-cutting: Inclusive of the full investment value chain Is short-termism a significant issue, and can we quantify the potential impact of longer-term behavior? What practical actions can market participants take to encourage and support long-term behavior? How can we measure whether we are making progress? 9

10 Evidence supports forgoing quarterly guidance in favor of long-term strategic roadmaps Moving Beyond Quarterly Guidance: A Relic of the Past Providing quarterly forward earnings guidance (as distinct from quarterly reporting) is increasingly rare with only 27.8% of the S&P500 providing such guidance. Quarterly guidance does not improve valuation or reduce volatility. Shareholders do not want quarterly guidance; fewer than 7% of investors want companies to offer guidance on any metric for periods of less than one year. Quarterly guidance can be harmful by attracting transient shareholders and increasing pressure on management to make short-term, value destroying decisions. Providing a long-term strategic roadmap for investors can be more effective at grounding the investor/corporate dialogue. 10

11 Investment contracts can promote long-term market behavior Institutional Investment Mandates: Anchors for Long-term Performance The terms that asset owners and asset managers agree in the awarding, reporting, compensation and termination of mandates set a short- or long-term mindset. Restructuring terms of mandates between asset owners and managers can provide better long-term incentives and lead to longer-term investing. Starting the contract negotiations with the long-term model terms can anchor the mandate to a more appropriate timeframe. Exploratory terms have been identified for pushing for even longerterm outlook. 11

12 Model Provisions for Long-term Investment Contract Fees Term Redemption Capacity Discount AUM fee for longevity Calculate perf. fee over 3-5 years, and defer 3- to 5-years with wide termination discretion Evergreen Consider investment impact of manager s ability to redeem inkind Cap strategy-level AUM for liquidityconstrained mandates (% of investable market cap) Use compounding hurdle rate Performance Reporting Disclosure Active Ownership Evaluation and Termination Present data from longest to shortest Changes in firm ownership levels or team Detail manager s engagement practice Document and monitor hiring reasons Provide commentary on longer-term periods vs. quarterly Choose and monitor KPIs Detail manager s proxy voting practice Measure turnover costs before terminating 12

13 Additional Questions to Explore Would alternative benchmarks that explicitly incorporate long-term thinking such as the S&P Long Term Value Creation Index or the asset owner s discount rate be effective? When are lock-ups appropriate for public equity strategies? Could built-in rebalancing counteract the typical performance-chasing cycle of fund flows? Should performance reporting consider the economic drivers of companies in the portfolio? How can asset owners and managers generate constructive dialogue on portfolio managers personal incentives, circumstances, and succession planning? Should asset owners define expectations on manager s engagement with companies? Would having a terminated manager continue to report performance for three years counteract the tendency for asset owners to terminate managers after poor short-term performance? 13

14 The goal is to create evidence-based change Current topics for research Risks and opportunities for long-term capital, distinct from short-term capital Drivers and impact of capital allocation process (buybacks, dividends, debt, reinvestment) The role of the corporate board in creating long-term value The investor/corporate dialogue and strategic engagement from long-term shareholders Capital markets innovations (e.g., new indexes/etfs, loyalty shares, alternative listings, PIPEs) Scorecard for Long-termism Measures of system-wide indicators of long-term or short-term capital allocation behavior Longer-term Topics of Interest Lessons learned from family or privately held companies that are applicable to public companies The changing role of sell-side research post MiFID II in creating short- or long-term behavior Characteristics of companies that switch from short- to long-term behavior Tools to instill a long-term culture in companies or investment organizations Duties of corporate boards and asset owners to focus on long-term value creation Regulatory improvements for long-term and retirement savings plans globally 14

15 In summary, long term capital allocation is critical and together we can make lasting change 1 Effective long-term capital allocation is fundamental for innovating and creating value, but short-termism is pervasive and costly to companies and society. 2 Our goal is to drive action through developing practical tools to combat short-termism and rebalance towards effective long-term capital allocation across the investment value chain. 3 Asset owners have a unique ability to affect the entire investment value chain by promoting long-term behavior. 15