Keeping each other in a short-term hold
Over the past few years, investors have used an ever shorter horizon on which they base their decisions. The management boards of listed companies are now complaining that Because of the enormous attention analysts and investors focus on the quarterly results, they invest less than would be beneficial for maximum value creation in the long term.
Although pension funds can be the ideal long-term investors, they also play a part in this preoccupation with the short term: especially on the public markets, attention is often focused on short-term performance compared to the benchmark.
If an internal or external manager shows underperformance for more than a year or two, you really have to have what it takes to get away without firing him.
For pension funds, passive investing has proven over the past decades to be a good, simple and reliable recipe for harvesting the market return. Nonetheless, passive investing in the market index also contributes to a short-term orientation: investors trust that the invisible hand of the market will ensure the right price and as such the capital invested will be used in a way that produces as good a return as possible in the long term.
The driving force of money
If many investors have trust in this invisible hand, who will make sure that efficient use is made of scarce capital for the long term? Pension funds manage the premium invested on behalf of their participants for a long term, decades in fact. At the same time, listed companies complain that they are not able to focus enough on the long term and consequently create less value than they could.
So it seems something is not right in the match between demand and supply of capital. And that is not all: as a side effect of their activities, many companies produce externalities, for example a relatively high quantity of CO2. In the short term, this may lead to profit maximisation, in the long term, this means they will be facing a problem both socially and economically.
Markets usually only factor in these kinds of issues for a relatively short horizon, I would say a horizon of one or two years. With a stronger focus on the long term, more insight into these risks becomes possible and they can be included in the investment decisions.
PGGM believes that by consciously using money to steer in a particular direction, we can reduce these negative side effects and perhaps even increase the long-term return and stability. Because of this, we like to talk with other parties and come up with ideas for how we could invest with more of a focus on the long term.
This does not mean, for the rest, that the existing recipe for investing will become worthless. At this moment, it seems to me that a wise investment portfolio will, in the long term, be more likely to consist of a combination of recipes, for instance index-related mandates and long-term mandates, rather than just one or the other. It will be a long time before pension investors embrace long-term investing and engage in it on a large scale.
Working together within FCLT
FCLT (‘Focusing Capital on the Long Term’) is a collaboration between businesses, asset managers, consultants and asset owners. PGGM is a member, along with a number of other pension investors worldwide. FCLT develops tools and approaches to help institutional investors and companies’ management boards with value creation in the long term.
There is a wealth of documents available on FCLT.ORG. One of my favourites is ‘Investing for the future: a long-term portfolio guide’, which contains five key recommendations for investing with more of a focus on the long term.
One of the five recommendations in 'Investing for the future' is: select and design benchmarks geared to long-term value creation. The S&P long-term index arose from an initiative from several FCLT members and, based on a number of mechanical criteria, provides a universe of companies that have proved able to achieve stable and solid returns. We see this index as a first step that will increase awareness about Long-Term Investing among investors and as such bring long-term investing a bit closer by. That is why we support this development.
The ideal index?
Is it the ideal index? No, probably far from it. Nor would that be possible to achieve in one go. Your first personal computer was also not the ideal machine. Is this index a good fit for PGGM and will PGGM be advising its clients to invest in this index? Again no, for a number of reasons:
The index does not reflect our exclusions and, for instance, PGGM’s CO2 policy for a number of its clients.
Together with our clients we have to work out in more detail how (passive) investing in an index relates to long-term investing. Is it really the case that a limited number of criteria can enable you to make a good distinction between companies that focus on the long term and companies that do not? And is that possible without any further opinion on the activities of these companies? For instance, is it okay if the products of these companies cause people to become obese or unhealthy?
PGGM is already exploring other routes within the listed equities portfolio which are focused on the long term or resemble this benchmark: the Quality strategy in the alternative equities strategies selects equities in a way similar to how the S&P long-term index does this. We are also taking the first steps this year in a mandate called Investing in Solutions/Equities. With this mandate, we aim to achieve a good return on the equities market in the long term and at the same time contribute to reducing four major worldwide problems: climate change, water scarcity, healthcare and food security.
We strongly believe in the combination of long-term focus and pension investing. But a great many questions still need to be answered before long-term mandates can be successfully used on a large scale.
This includes questions like: what characteristics does a good mandate for long-term investing have and how do you keep your finger on the pulse in the interim? Is it wise to outsource this kind of mandate to an external asset manager or is it better to manage it internally? And: will the extra returns or reduced risks of long-term investing outweigh the extra costs which a long-term investor will probably be facing?
These are the kinds of questions we will address in FCLT. The coming years will be dominated by the development of instruments to be able to take manageable steps and get more experience.