It is easy to be transfixed by the rising dominance of hedge funds and active traders in equity markets who seem to epitomise short-termism in investors. Hedge funds are thought to be behind at least half of share trading volumes in London on any one day, and whenever a bid battle is in the offing they appear en masse, buying and selling shares, driving up share price volatility.
But short-termism is an accusation that is levelled more broadly at the fund management community, too. Critics point out that the average stock market investment is now held for less than 12 months compared with seven years in the 1970s.
Sir John Sunderland, outgoing chairman of Cadbury Schweppes, articulated some of these criticisms in 2005, when he was president of the Confederation of British Industry. He condemned institutional shareholders, banks and hedge fund managers for their lack of transparency and long-term perspective. “It may be old fashioned, but I view a shareholder as a shareowner – someone whose interest in the success and prospects of the company lasts more than three weeks,” he said.
Sir John’s comments still rankle with some fund managers but they highlight the difficulties that most investment managers face. Few goods or services are as intrinsically long term as a pension or insurance fund. After all, individuals start saving in their 20s and carry on until they die. When these savings are aggregated into one fund, the life of an investment fund can span many generations.
And as people live longer, the outlook of their pension and insurance funds also lengthens.
The job of pension fund managers and trustees is how and where to invest today in ways that can guarantee the retirement income of future employees when they retire in, say, 40 years. Poor decisions by investment managers – few of whom last more than three years in a job – can do lasting damage to portfolios that may not come to light for years.
For this reason, investment managers are checked regularly to ensure that they are not drifting from their remit or that returns are not falling to levels where there is no hope they can cover future obligations to scheme members.
Several times a year, regulators, pension fund trustees and investment consultants monitor performance and returns, measuring funds against benchmarks and peer groups and structuring pay and bonuses around their short-term performance.
In turn, say company executives, fund managers subject them to short-term goals and what many call “the tyranny of quarterly earnings disclosure”.
Investment managers are increasingly aware of the problem. At last year’s annual International Corporate Governance Network conference of 400 fund managers, Mark Anson, then chairman of the ICGN and chief executive of Hermes, the UK’s biggest pension fund, castigated short-term investors who “rent” rather than own shares. He blamed them for some of the worst of recent failures in good corporate governance that have destroyed shareholder value.
Mr Anson said it was partly the fault of the clients of asset managers – that is, the trustees of pension funds – who pressurise portfolio managers to outperform benchmarks and stock market indices on a quarterly basis. This in turn encourages managers to turn over their portfolios regularly in pursuit of short-term price movements. And this puts pressure on companies to report strong short-term earnings, rather than pursue long-term growth. “It is a vicious circle,” said Mr Anson.
However, there are changes afoot, driven – at least partly – by consumers who are beginning to embrace social, environmental or economic sustainability as a criterion for investment. According to fund managers, their clients are demanding that their money managers think about issues such as global warming, and apply ethical, green or socially responsible investment overlays (SRI). Flows into ethical and SRI funds have more than quadrupled in the past year or so. Eurosif, the European Social Investment Forum, estimates SRI accounts for about 15 per cent of total European funds under management.
The concept of sustainability – managing a company for the long term – is also being applied more broadly. And where once phrases such as SRI and sustainability were the preserve of new-age hippies, now executives and fund managers bandy them about without embarrassment.
The new mood is pushing investment managers to actions that would have been unthinkable a decade ago. Last year, a group of UK fund managers, including Hermes and F&C Asset Management, wrote to the UK government over its decision to halt a Serious Fraud Office investigation into allegations of corruption involving BAE, the UK defence group, in which they were invested. It was a landmark moment when the forces of capitalism moved against their own short-term interests.
But F&C and Hermes said the government’s decision risked the UK’s reputation as a leading financial market and could have a long-term impact on the cost of investing and doing business in the UK. They were concerned that the UK government’s action would signal that it was prepared to turn a blind eye to accusations of fraud and corruption if that was in Britain’s short-term economic interests.
There have been a number of other initiatives in the fund management industry to foster a longer-term outlook. In 2004, in the UK, a collaboration of about 20 trustees, executives and investment consultants, including the London Pension Fund Authority, set up the Marathon Club to promote long-term investing and responsible ownership in practical ways to help trustees of funds change the way they look at investment.
The initiative came after the bull market in telecoms, media and technology stocks up to 2000 and the subsequent bear market in equities between 2000 and 2003. Members of the Marathon Club pointed out that fund managers’ target to match or beat equity indices over those periods resulted in a “widespread misallocation of capital”. In contrast, funds whose outlook spanned decades and were not constrained by short-term performance targets. For example, some college endowment funds in the US managed to avoid the worst excesses of both bull and bear markets.
Also in 2004, half a dozen fund managers, including PGGN, the Dutch pension fund, and the UK’s Universities Superannuation Scheme set up the Enhanced Analytics Initiative to promote research into good corporate governance, the management of human capital and of the environment. EAI members – who have more than $2,000bn under management – agreed to allocate 5 per cent of brokerage commissions with brokers and analysts looking at extra-financial indicators.
More recently, the United Nations set out its principles for responsible investing, which also embraced sustainability.
In the US, Al Gore, former vice-president and and this year’s winner of the Nobel Peace Prize for his work raising awareness of climate change, joined forces in 2004 with David Blood, a former Goldman Sachs banker, to create Generation Investment Management. The company aims to deliver good long-term returns using stocks picked on the basis of sustainability.
Earlier this year, Mr Gore brought his campaign to the UK urging the country’s pension industry to stop rewarding fund managers and company executives on the basis of short-term results if it wanted to achieve sustainable investment returns. He told a conference of the National Association of Pension Funds that a three-year timeframe for calculating incentives would be more reasonable for pension funds trying to match their long-term liabilities with long-term returns.
However, on this front, Mr Gore has yet to gain a big following. Persuading trustees, companies and regulators to break ranks and change the way they assess fund managers remains an uphill struggle. Watson Wyatt, the UK consultancy, has put together about 40 so-called long-term equity mandates that have a 10-year horizon and the freedom to pick out stocks whose true value may take time to become clear to the market. So far, about £2.5bn to £3bn is in these mandates, representing between 5 per cent and 15 per cent of a scheme’s total assets. “But it is still early days,” says Roger Urwin, global head of investment consulting at Watson Wyatt.
He estimates 99 per cent of UK funds are still oriented to benchmarks and the best way of beating benchmarks is to buy or sell shares at better prices than rivals. Looking at the long-term fundamental value of a business is, for the most part, secondary.
