There are lots of data to suggest that public companies are obsessed with short-term performance, which means they tend to choose short-term profits ahead of long-term organizational well-being. Why? It’s complicated, but I’d argue that one of the key reasons for this behavior stems from the influence of their investors (i.e., the financial services industry), who demand quick returns ... or they’ll sell. And why are these financial service providers focused on short-run returns? The financial service providers (e.g., asset managers) have, surprise, investors of their own to deal with (e.g., pensions, sovereign funds, endowments). And these asset owners tend to demand returns over a short time horizon from their asset managers ... or they’ll sell. And why do pensions and sovereign funds want short-run returns when they are ostensibly long-run investors? Because the boards of many of these institutions simply don’t get it — they don’t understand the benefits of being a long-term investor and, more to the point, they don’t trust their management and staff. As a result, they assess their management and staff based on short-term metrics. And it doesn’t stop there. As Adam Dixon at Bristol University and I argued in a paper back in a 2012, policymakers are also to blame for institutional investors’ short-termism. Why? Because they push a form of blunt transparency that allows for all of the aforementioned insanity to function.
In sum, the world’s “long-term investors” have, ironically, become drivers of a capitalist system that is overly focused on short-term performance. Indeed, we’ve got long-term investors taking their cues and drawing their benchmarks from a world that is already moving toward short-termism. Not good. We have to change this. Because, in my view, of the $95 trillion that the OECD says is sitting in long-term investment organizations, there’s maybe $5 trillion of it that is truly being managed in a way that can be described as “long term.”
As it turns out, there are other, much smarter people who seem to agree with this point of view. A recent paper by McKinsey & Co. global managing director Dominic Barton and Canada Pension Plan Investment Board chief executive Mark Wiseman had this to say:
“Simply put, short-termism is undermining the ability of companies to invest and grow, and those missed investments, in turn, have far-reaching consequences, including slower GDP growth, higher unemployment, and lower return on investment for savers.”
And Barton and Wiseman go on to argue, rightly in my opinion, that:
“... the single most realistic and effective way to move forward is to change the investment strategies and approaches of the players who form the cornerstone of our capitalist system: the big asset owners. ... If they adopt investment strategies aimed at maximizing long-term results, then other key players — asset managers, corporate boards, and company executives — will likely follow suit.”
Barton and Wiseman then go on to drop some science on us about how long-term investors can extend their time horizons. It’s a great paper. Go read it.
But I do think that they — and the others out there who look at these issues — could do a better job of making the benefits of long-term investing truly palatable to the investment community. In other words: It’s fine to say that companies focusing on short-term results won’t be able to make long-term investments, which in turn hinders GDP and employment. But I think we can make the case in a way that clearly resonates with institutional investors. Why bother? Because the motivation to change will first come from a recognition of the benefits of doing so. So, that’s what I’d like to do below. But before I can explain why being a truly long-term investor is awesome, let me run through what I mean by “long-term investor.”
There are certain innate characteristics that make it possible for investors to be long-term investors (LTIs); call these their DNA, or their nature. Then there are the factors that are within their control that allow them to execute long-term strategies; call these their upbringing, or their nurturing. And then there are those things that they actually do with their nature and nurture; call this their behavior.
*Nature. The characteristics of an LTI are fairly straightforward. They have assets that exceed any contingent or explicit liabilities. Alternatively, they may have liabilities, but those liabilities aren’t due for several decades or more. As such, the LTIs have few if any “calls” on their capital, which means that there are few if any outflows, and the LTIs can be more aggressive than short-term investors. Why? Because they won’t be forced to sell in volatile markets – they can stay the course, if they so choose.
*Nurture. LTIs tend to have the following: good governance that understands the investment business; a solid in-house capability with quality human resources; a sound culture of collaboration, value creation and risk taking; unassailable independence; top-caliber operational, enterprise and investment risk management; and a sophisticated investment decision-making process. You get the picture.
*Behavior. With the right nature and nurture in place, the ingredients are there for an investor to truly behave like an LTI. And what does this behavior look like? Well, this may include taking countercyclical positions or adopting forward-thinking environmental, social and corporate governance-related strategies and tilts. LTIs can allocate their portfolio according to secular themes that, one day, will disrupt markets, such as population aging, food security, water scarcity, climate change or even the rise of Africa. LTIs can take on strategies with deep J-curves (like these guys) and play in markets that short-term investors cannot. This isn’t about “buying and holding” necessarily. It’s about being smart about your long-term competitive advantages and using them to maximum effect. When markets are crashing because of illiquidity, LTIs can step in and catch that falling knife (not because they think it’s right for society, and it is, but because they’re going to get compensated for doing so when markets rebound, which they usually do). LTIs can allocate into markets that might otherwise be deemed inefficient or illiquid. They can get paid for lockups. They can sell insurance. You get the picture.
Doesn’t all that sound rad? Don’t you want the ability to do these amazing things? No? Well, if the appeal of all this doesn’t immediately stand out, let me simplify it in a way that I think investors will understand: There’s simply no portfolio of assets that a short-term investor can hold that a long-term investor cannot also hold. However, there are plenty of portfolios that a long-term investor can hold that a short-term investor cannot. And that means, thanks to the power of diversification, which offers the only free lunch in investing, that being a long-term investor is undeniably better than being a short-term investor.
So, let’s get on with getting long.