Institutional investment managers and corporations alike have been criticized in recent years for an excessive focus on short-term performance, a practice that can lead to suboptimal outcomes and undermine long-term value creation.
Critics argue that looking further ahead might uncover risks and opportunities that would otherwise elude the investors or corporations focusing on shorter-term goals. They say a longer view might discover systematic exposure to risks particular to an industry or company, or vulnerabilities to the entire financial system. And a longer view might promote investment and corporate managers to undertake business and investment opportunities that would take a longer time to nurture at the expense profits and returns in the short run.
Mindy Lubber, president of Boston-based Ceres, a coalition of investors and environmental groups encouraging companies to address sustainability issues, calls short-termism “quarterly capitalism.”
However, the issue of perceived short-termism and the appropriate investment horizon raises questions of fiduciary duty, and proposed solutions should not be adopted without thorough examination of the implications and possible adverse consequences.
Fiduciaries have to evaluate and manage investments solely in the interests of pension fund participants or, in the case of endowments and foundations, the future beneficiaries of their assets. The horizon can stretch generations.
While it might appear the investment community is driven by quarterly evaluations of investment manager and corporate management performance, in reality fiduciaries have to focus on many investment horizons.
For fiduciaries, some focus on the short term is important to ensure availability of funds to pay near-term benefits. At the same time, they have to keep their eye on the long term because the payout of the bulk of their obligations has a long time horizon.
Fiduciaries must be aware of efforts to tilt the focus of companies toward a long-term perspective. That change, while it could improve long-term outcomes, also exposes investors to opportunities and risks that could possibly give some shares more than one vote. Fiduciaries have to examine and be prepared to address such proposals solely in terms of the interests of their funds and participants.
Lengthening the outlook of corporations and investors, and implementing incentives to encourage such a transformation, will be a challenge.
Mercer LLC, the Stikeman Elliott LLP law firm and the Generation Foundation — an advocacy arm of Generation Investment Management, whose chairman is Al Gore — addressed the issue of short-termism in an extensive new study: “Building a Long-Term Shareholder Base: Assessing the Potential of Loyalty-Driven Securities.” The study found “broad consensus” that short-term behavior of investors “is driving non-optimal behavior by companies.”
A report in 2013 commissioned by the U.K. House of Commons Business, Innovation and Skills Committee discussed the potential impact of offering different voting rights to long-term investors. In addition, the Mercer report mentions the European Commission is considering a proposal to grant long-term shareholders more voting influence.
The Mercer study suggests incentives to promote long-term investment could include paying extra dividends, or the grant of warrants or additional voting rights granted to investors who hold shares for the long term, such as a minimum of three years.
However, few investors surveyed embraced the concept, according to the study written by Jane Ambachtsheer, Mercer partner, and Ryan Pollice, Mercer senior associate, and two others from Stikeman Elliott. The reasons for rejection include the fact it contravenes the concept of one-share/one-vote or the idea that eligibility based on a holding period might produce outcomes inconsistent with the objective.
Pension funds and other asset owners have long been sources of patient capital to encourage companies to take a long-term perspective. Further, a recent study found pension fund holding periods are not that short.
A 2012 study, “Institutional Holding Periods,” found annual U.S. equity turnover of more than 1,000 pension funds was stable in recent years, ranging from 42% to 46%, between 1999 and 2008. By contrast, U.S. equity annual turnover by mutual funds ranged from 69% to 77% from 1999 to 2009.
Further, loyalty-driven shares, or transforming the one-share/one-vote concept, isn't the only means to encourage long-term value creation.
Pension funds have understood the importance of patient capital when it has suited their needs and have implemented their own strategies. When the market hasn't served their interest they have turned to private equity, which is not subject to the same pressure of quarterly reporting as publicly traded companies.
In fact, the private equity and debt markets have become bigger than the public equity and debt markets, according to a 2012 Securities and Exchange Commission report. In 2010 and 2011, the latest year of the report, private equity and debt offerings in the U.S. market surpassed public equity and debt offerings,
In addition, pension funds have been longtime shareholders through index funds, although the Mercer study points out index funds don't necessary promote the objective of lengthening corporate perspective. Steve Lydenberg, a partner for strategic vision and direction at Domini Social Investments and founding director of the Initiative for Responsible Investment at the Hauser Center for Non-profit Organizations at Harvard University, in a 2013 study “Reason, Rationality and Fiduciary Duty,” calls indexers “perpetual investors making short-term investments, forever” rather than long-term investors, depriving “corporate managers of intelligent feedback from the capital markets through the price mechanism,” thus undercutting efficient allocation of resources.
Despite the impression, many pension fund indexers act like long-term owners. They actively engage corporations through proxy voting and engagement on corporate governance issue to improve corporate performance, showing that selling shares is not the only way to influence corporate outcomes.
Studies dismissing short-termism fail to recognize the short-term investor can have just as much impact on the strength of a company as a long-term investor. Pension funds and other asset owners participate in arbitrage and shorting strategies, attempting to profits from projections of misaligned or declining value. Generally these strategies can promote better valuation and corporate performance. They warn of problems, potentially relieving investments from overinflated investments that could ultimately result in big price collapses for other investors and putting companies on notice that corporate transformation might be needed.
Both patient investing and short-term investing can simultaneously serve the long-term sustainability of investors and corporations. Efforts to steer investors to one side of the horizon do so at the risk of undermining the constant balancing as the dynamics of the markets and economy change strategies and potential outcomes.