Our obsession with quarterly corporate earnings is a market failure, according to Colin Melvin, CEO of Hermes Equity Ownership Services, and can only be corrected by action from institutional asset owners.
Some years ago, a global collective of institutions and funds managers, including the $14.8 billion HESTA, pledged to collaborate and produce high-quality, long-term investment research that in part sought to redress this market failure, recalls Melvin, a shareholder engagement specialist. This research was called the Enhanced Analytics Initiative.
The outcome was great research that was never really used by funds managers.
He says asset owners should overhaul the terms of the mandates they issue to managers so they are paid for proven long-term investment performance, not quarter-to-quarter rankings.
“The mandates we award to them drive short-term decision-making, churning and transaction costs. We’re not realising the benefits of long-term horizons because we’re sponsoring trading and transactions.
“One way of looking at the investment industry is as a number of participants generating transactions and benefiting from them. We sponsor that.”
Melvin says the investment industry’s short-termism has worsened over time. This is not caused by malice or recklessness among investment managers, but is simply the way the industry, and the way it measures performance, has evolved.
Ratings agencies shoulder the blame for publishing performance league tables, but they are only symptomatic of a deeper ailment “to benchmark, compare and rate,” Melvin says. “It has arisen as a consequence of the need to measure.”
He remembers a conversation with a funds management colleague, who said the long-term could be seen as a series of short-terms. “It may look that way,” Melvin replied, “but you’re profiting from those short-terms while your beneficiaries are not.”
Essentially, engagement with funds managers does not do enough: mandates must be structured so that funds are provided with more transparency of managers’ actions so they can see if managers are truly investing for the long-term.
The £32 billion ($51 billion) BT Pension Scheme, Hermes’ owner, is mulling over whether to introduce this policy.
Such measures would be aligned with the notion of fiduciary duty, which has become a rallying call for institutional investors, but can be described in a working definition as the trust exercised in taking care of beneficiaries’ assets.
Melvin, who played a central role in developing the United Nations Principles for Responsible Investment (UN PRI), advises investors to revisit principle one, which concerns investment decisions.
“It’s really about how you invest: what sort of mandates you give to funds managers. If you judge them on their annual performance, that’s what they’ll prioritise.”
The UN PRI seems to assume that pension funds make investment decisions, but should rather focus on how asset owners select managers, Melvin says.
He says managers’ focus on short-term earnings can be distressing for companies, since their standard discussions with shareholders are not about the business and its long-term profitability but the current price of its shares.
He says engagement targets were often pleased to be pulled up on their slack practices, talk about the operations of their business with long-term shareholders and focus on generating long-term value. For these companies, “it’s a relief”.