Return of the long-term investor

Al Gore, the former US vice-president turned environmental campaigner, recently conducted a whistle stop tour of the European continent to push his mantra of sustainable investment. He took the opportunity to chide the investment community for its short-termism.

Mr Gore, chairman of London and Washington DC-based Generation Investment Management, believes mounting short-termism is hurting investment returns, as well as preventing companies from developing the long-term strategies they need to reduce their carbon footprints.

“If you want management according to long-term horizons but you incentivise on a quarterly basis, will you be surprised if performance is maximised on a quarterly basis and if there is a tension between meeting targets and long-term objectives?’’ he asked delegates at the National Association of Pension Funds’ conference in Edinburgh.

Pointing out that the average stock market investment is now held for less than 12 months, compared with seven years in the 1970s, Mr Gore said: “Eighty per cent of a firm’s value builds up over a business cycle and a half, so if you are buying equities then selling them a few months later, clearly the aim is not to participate in the build-up of value.”

But how easy is it for institutional investors to break this short-termist cycle and find fund managers willing to invest for the long-term? Will they be rewarded for doing so?

The first hitch is that few asset management houses are geared to investing for the long term. “Finding houses has been quite hard work, it’s a bit of a niche style,” says Roger Urwin, global head of investment consulting at Watson Wyatt, which has been feeding a steady trickle of its clients into long-term mandates since 2003.

“There are very few people who supply the mandates that Gore is looking for,” says Yusuf Samad, investment consultant at Hewitt Associates and a founder of the Marathon Club, a collaboration of trustees, executives and specialists promoting long-term investing and responsible ownership.

There is clearly a chicken-and-egg scenario – few asset managers will set out their stall to invest long-term unless they see a market for such wares. And pension fund trustees, a conservative bunch at the best of times, may prefer to play safe and follow the herd.

Nonetheless, there has been progress. Watson Wyatt has secured more than 40 long-term mandates for its UK clients, who are typically investing 5 to 15 per cent of their assets for five to 10 years. Crucially, all of these are still up and running.

The Marathon Club has helped facilitate mandates with a number of niche long-term investment houses, such as London-based Marathon Asset Management, Bermuda’s Orbis Investment Management and Southeastern Asset Management of Memphis.

In many ways this investment philosophy is far from new, echoing the distinction between investment and speculation elucidated by Benjamin Graham and David Dodd in the 1940s.

But Mr Urwin stresses that Watson Wyatt’s long-term mandates are different in nature from standard relative return equity portfolios. If a fund manager is confident that, providing his investment philosophy rem­ains robust, he will not be dumped after a couple of quarters of underperformance, he will have more freedom.

“They are not linked to an investment benchmark but are relative to an absolute return of, say, 6 per cent per annum above consumer price inflation. That is what equities have typically done over time, plus 1-1.5 per cent to reflect the skill of the manager. Short-term mandates emphasise the price in the price/earnings ratio, long-term mandates are targeting sustainable earnings.”

Mr Samad also points to the tyranny of the benchmark. “For the Marathon Club, long-term investing is not about the term of the contract, it’s the approach that you take, looking at the fundamentals of the business rather than checking against the index.”

So far these mandates have not really been tested – in the equity bull market since 2003, CPI plus 6 per cent has not been the most demanding of targets. But Mr Urwin does detect “quite a lot of enthusiasm” among his pioneering clients. “The early experience is that they have performed better than short-term mandates.”

But is there any reason to believe that these long-term mandates should outperform? Mr Urwin thinks so, pointing to greater opportunities for managers and more scope to use their judgment.

This argument grows stronger if the environmental concerns also posited by Mr Gore come to pass. “Companies are responsible for 50-60 per cent of greenhouse emissions, according to the [UK’s] Stern report [into climate change], therefore companies will be placed under pressure to change,” Mr Urwin says. “Do you give a premium price to greener companies? It’s the long-term mandates where these factors are likely to be weighed up.”

Whatever the rationale, the slow but steady emergence of longer-term investment philosophies is likely to prove an inconvenient truth for managers unwilling to play ball.

“We have seen an increase in mandates,” Mr Samad says. “In the last three years we have done many, many mandates with managers that take a very long-term view.”