While the leaves were changing to bright reds and vibrant yellows, many asset classes across global markets were very volatile, with all market participants looking toward governments, corporate leaders, and other stakeholders to provide near-term guidance on a wide array of items such as interest rates, currency devaluations, earnings, returns of capital, and general solutions to all the world’s problems. Perhaps part of the solution to this near-term volatility is to shift the focus to a longer-term outlook approach.

The subject of short-termism versus long-termism has become a growing topic among corporate leaders, corporate boards, governments, and capital market participants. Much has been written on the subject, and, in 2013, the Canada Pension Plan Investment Board (CPPIB) and McKinsey & Company brought the subject to light when they cofounded their Focusing Capital on the Long Term (FCLT) initiative, an endeavour focused on changing behaviours in both the business and investment worlds. They identified four actions that institutional investors, corporate directors, and management could take in order to influence other market participants to get capital working for the longer term:

• reorient portfolio strategy and management of institutional investors;
• unlock value through engagement and active ownership;
• improve the dialogue between investors and corporations; and
• shift the board’s focus to support long-term strategy and sustainable growth.

Corporate boards have begun to make the shift. (Incidentally, this topic has been a keynote subject at the Institute of Corporate Directors (ICD) annual gatherings over the last two years.) In June, 60 percent of ICD directors surveyed agreed they have a responsibility to do more in tackling short-termism. Fifty-one percent said they believed their own board could do more to support the cause, including selecting the right board members, spending more time focusing on long-term strategy, and engaging in dialogue with key stakeholders (including long-term investors).

Can long-term investors influence corporate decision-making policies for the better? They can, according to Harford, Kecskés, and Mansi’s Feb. 1, 2015, research paper “Do Long-term Investors Improve Corporate Decision Making?” The authors conclude that long-term investors have the motive and means to monitor corporate managers, resulting in corporate decisions that are consistent with maximizing long-term shareholder value. Positive drivers include restraining numerous corporate misbehaviours such as earnings management and financial fraud and strengthening internal governance.

Shareholders benefit through higher stock returns, greater profitability, and lower risk.

The authors surveyed approximately 3,000 firms over a 30-year period to test their initial hypothesis. Of particular note, in time series regressions, a long/short portfolio based on investor holding-period horizons earns positive abnormal returns of roughly 30 basis points per month, with profitability and risk being the main drivers of the outperformance. The authors found that realized earnings are increased by about 0.5 percentage points of total assets and are generated by sales growing faster than costs, and there is lower volatility.

If corporate boards are beginning to make the shift, and if underlying research supports the case for generating better returns in the longer term, capital markets participants also need to think about how, and to what degree, to make the shift. One of the growing topics among professional investors revolves around quarterly versus semi-annual financial reporting, a topic that has gained momentum in the U.K. and in Europe. For portfolio managers, analysts, and other capital markets participants, quarterly reports have become somewhat boilerplate-like and, in many cases, create undue noise, especially as new information distribution systems (such as Twitter) require almost instant responses. However, they’re a staple of the information investors rely on.

In March 2015, FCLT asked nine institutional investment firms representing approximately $6 trillion of assets under management to recommend five core areas to look at in making this shift:

• investment beliefs – create the foundation;
• risk appetite statement – have a comprehensive approach focused on the longer term;
• benchmarking process – select or construct a benchmark for the longer term;
• evaluations and incentives – look at process, behaviours, and consistency with an emphasis on the longer term; and
• investment mandates – align behaviour and objectives.

Progress on these fronts is crucial for investors like CPPIB that are seeking to maximize value not only for stakeholders or clients today but for future generations of beneficiaries, says Mark Wiseman, president and CEO of CPPIB and co-chair of FCLT. “CPPIB is acting to advance a longer-term focus in our own investing activities via our investment partners in both public and private investments and also by engaging directly with companies in which we invest.”

Of course, like building a great business, none of these things can happen or be implemented overnight. However, as investment professional leaders, should we not be asking the same of ourselves that we are asking of our investments? Maybe 2016 is the year to make progress toward that ask.

Sources:
www.fclt.org

Long-term Portfolio Guide: Reorienting portfolio strategies and investment management to focus capital on the long-term 
<http://www.fclt.org/content/dam/fclt/en/ourthinking/FCLT_Long-Term%20Portfolio%20Guide.pdf>

“Do Long-term Investors Improve Corporate Decision Making?” by Jarrad Harford (University of Washington), Ambrus Kecskés (Schulich School of Business, York University), and Sattar Mansi (Virginia Tech), Feb. 1, 2015.