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This time it has got to be different – why responsible investment needs to get seriously long-term
Rob Lake of the PRI looks at the challenge and the response.
The challenge
As I write this, the media are full of the latest examples of the damaging consequences of companies’ drives to maximize short-term financial performance at any price. Barclays’ manipulation of Libor for the benefit of its own trading positions and its traders’ bonuses; GlaxoSmithKline being fined $3 billion for marketing anti-depressants for uses for which they were not licensed; investment banks overcharging pension funds and other clients for foreign exchange services; and banks rigging municipal bond auctions in the US and depriving cash-strapped local governments of interest payments they would otherwise have earned – presumably with knock-on impacts for underfunded public pension funds and their beneficiaries. But we’ve been here before. We take it for granted in the ESG/RI/SRI world (take your pick on the terminology – we know what we mean) that short-term performance maximization militates against longer-term value creation driven by (among other things) a fuller consideration of environmental, social and corporate governance factors. Research shows clearly that companies forego investment opportunities with positive long-term net present value in order to satisfy the market’s short-term performance expectations. Companies have little incentive to invest in serious emission reductions (beyond the lowest of the low-hanging fruit) if their shareholders would prefer short-term earnings or share buy-backs over capital expenditure or R&D with a longer-term payback that may be uncertain if carbon prices remain low or nonexistent. Why invest in human capital development when expenditure on training is a cost in the accounts
and the markets salivate when you announce lay-offs? Short-termism in investment strategy can be seen in the well documented increase in portfolio turnover that has taken place across the market as a whole in recent years. High turnover, driven in part by investment managers’ incentives to deliver short-term performance to their clients to avoid being sacked, is both a symptom and a cause of short-termism. It can be seen as the transmission mechanism between the short-termism of investors and that of companies. Yet studies show that high turnover and momentum-driven investing contribute to asset mispricing and bubbles, and the inefficient allocation of capital from a long-term perspective. Some front-line portfolio managers acknowledge that the way they are often incentivized to behave is not aligned with their clients’ real long-term interests. The way the market currently works, through the investment chain from asset owners via investment managers (external or in-house) to companies, does not always serve the true long-term interests of the millions of ordinary people worldwide who save through pension funds or insurance products. Their financial interests are not well served in that returns are depressed by short-termism and financial instability. Their interests as citizens, employees and human beings with values are not served in that climate change, biodiversity loss, human and labour rights and other sustainability challenges are not adequately addressed. A double whammy of market failure.
The response
The continuing convulsions and revelations in the wake of the financial crisis give the responsible investment community an opportunity – indeed a responsibility – to
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