If managers want to reinforce their long-term investor bona fides they should adopt appropriate time horizons for the investments they make, disclose more about how long they hold assets, and reconsider paying themselves based on short-term results. Only then will the interests of asset owners and the managers they employ be truly aligned. 

In a world where short-termism is becoming increasingly prevalent, uncovering the truth around market value and company governance is increasingly difficult.  

At the Top1000funds.com Fiduciary Investors Symposium in Toronto, MFS Investment Management president Carol Geremia said players in the investment value chain need to adopt different performance metrics and mindset if the industry wants to realign towards long-term value creation.  

MFS is known for establishing the world’s first mutual fund a century ago and today has $606 billion assets under management.  

Geremia told the symposium that managers today must take five times the level of risk to get the same amount of return as 30 years ago.  

“We all know that rates are slowly changing now, but with them being so low for so long, we’ve all had to just dial up risk endlessly,” she said. 

“Then what we did is build a measurement system as we took more and more risk to hold ourselves accountable. And we didn’t get longer with the risks we were taking, we actually got shorter. 

“I’ve been in the business 40 years, and I’ve always learned that’s not how you take on risk – you extend your time horizons, you don’t shorten them. Yet, we’ve built this measurement system, because it’s so hard to figure out the markers to the longer-term destination.” 

Geremia said it is time the industry considering adopting more comprehensive metrics such as the holding horizon, to encourage long-term thinking.  

“You could go to every single active manager in the world and ask them ‘what is your average holding horizon of a stock inside your portfolio?’ That should be the number one statistic if we want to measure long term investing,” she said. 

“The industry has now gone down to less than two years [of holding horizon]. Sorry, that’s not long-term. So if you say you’re long term [investors], prove it.” 

Another approach is to set up an appropriate long-term incentive structure, Geremia said.  

“I don’t think paying on short-term performance – if you’re going to say you’re a long-term firm – is aligned. So change your compensation metric,” she said. 

“We did quite a long time ago – we do not pay on short term results. It changes how people are managing the money, there’s no question about it.” 

However, Geremia said these measures are not justifications for short-term underperformance, but the start of a conversation that aims to address a gap in industry expectations.  

Like most “long-term active fund managers”, she said MFS aims to outperform over a full market cycle. Most of the industry define that as seven to ten years, but most can only tolerate underperformance for three years.  

“A full market cycle is not one, it’s not three, and it’s not five years, yet the industry has anchored to those periods of time. 

“Being a long-term active manager in the public markets is really uncomfortable. 

“It is high hurdles, and difficult to think about how we measure long term or hold each other accountable for the future. 

“There are some great ideas out there, and I’m inspired with what collective work we can all do.” 

CFA Institute presents its views on net zero, and climate-related disclosures by public companies.

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As the global association of investment professionals, CFA Institute monitors key debates and evolving developments across the investment industry. In recent years, one significant topic of discussion has been the role and application of environmental, social, and governance (ESG) information in the investment management process.

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Pictet Asset Management head of private debt Andreas Klein says “mainstream” private credit investments have probably run their course as buyout activity decreases and global regulators up their oversight of the booming asset class. Instead, investors should consider “micro-niches” such as the lower-mid-market, litigation and biosciences financing, he argues, but warns these emerging corners of the market come with hidden and unique risks attached.

Buyout volume as a percentage of S&P market capitalisation is at the lowest level ever recorded, Pictet Asset Management head of private debt Andreas Klein told the Fiduciary Investors Symposium.

The statistic suggests a dearth of demand for capital, which, coupled with “excess dry powder” from enthusiastic institutional investors, provides some evidence for the topical assertion that cracks are starting to appear in the veneer of the private credit boom, Klein said.

“There are definitely some headlines and … media coverage about the heat within the market and some of that is definitely justified,” he told the symposium hosted by Top1000Funds.com at the University of Toronto, Canada, last week. “You have this imbalance between supply and demand. And consequently, it’s obvious what happens, there’s a pressure on returns.”

Global private credit assets are estimated to have doubled in just a few years to surge past $2 trillion, according to the IMF, which has warned the market presents a potential “vulnerability” for the financial system.

Klein said the penetration of private credit as a capital source for borrowers continues to increase, due to myriad macro and geopolitical factors especially the retreat of banks from certain lending markets due to balance sheet mismanagement (think Silicon Valley Bank, First Republic and Credit Suisse) and higher regulatory standards, alongside lower public issuance.

But he outlined Pictet’s thesis that this “golden age of private credit” is “unlikely to stick around”, even though the high default cycle some had anticipated in the post-pandemic era never really eventuated, giving some false hope to the market.

Micro-niches over mainstream

“There’s certainly some elements of concern going on,” Klein said. “Now, do we still think that there’s value to be had in the private credit markets? I obviously wouldn’t be sitting here if we didn’t think so. It’s just you need to think about credit from a different perspective.

“The mainstream solutions have probably run [their] course. Yet, the vast, vast majority of assets going into the private credit space is into mainstream funds. So where can you still find value?”

He argued that the opportunity for pensions and sovereigns lies in “micro-niche” markets and strategies. “We like the lower-mid market, for example, we think it’s a much more insulated market,” he said. “We think the supply and demand dynamics within the lower-mid market are much more balanced. Structurally, there are more small corporates than there are large corporates and hence the borrower universe is much wider.

“In 2008-2009 it was deposit money that regulators were focused on – now it’s really pension money that regulators are focused on.” – Pictet Asset Management head of private debt, Andreas Klein

“Furthermore, the idiosyncratic risks that you find within a heterogenous market environment allows you to structure around that risk and drive incremental yield whilst protecting yourself against that. And we’ve seen that the lower mid market has been much much more resilient than the larger cap in terms of margin preservation.”

Other micro-niches singled out included litigation debt finance, biosciences finance and significant risk transfer, which usually involve the transfer of credit risks from banks to investors, often using synthetic securitisation.

“These are just areas that you can think of that are uncorrelated that have potentially diversification elements and bring resilience into the wider portfolio,” he said. “It comes down to manager capability for origination, particularly on proprietary origination, being able to find these assets that have these specific characteristics within micro-niches that are protected.”

‘Orange flags’ and ‘shadow banks’

Asked whether government regulation posed a threat to the market by potentially limiting the appetite of asset managers to take up the lending mantle forfeited by banks, Klein said more regulation was not only likely, but welcome.

“I think there’s a lot of underlying systemic risks within this ‘shadow banking’ market,” he said. He warned of a number of prevalent “orange flags” investors should look out for.

“There’s a lot of hidden leverage, whether that is at fund level [or] leverage within the underlying assets; [there is a] significant increase in the number of continuation vehicles for private equity vehicles [and an] emergence of ‘hold co.’ financing or NAV financing to provide liquidity to underlying LPs. These to me are all signs of orange flags that mask a larger underlying issue.

Net zero requires transformational changes and significant investment. This guide aids industry leaders in implementing net-zero investing. It offers practical guidance that stresses the importance of mindset shifts and highlights strategies for success.

All recent net-zero research and policy insights can be found on the Net-Zero Investing topic page.

By Roger Urwin, FSIP

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