Somewhat ironically, I’ve been involved in the debate about ‘short-termism’ for nearly a decade. I was at the Universities Superannuation Scheme (USS) in 2003 when we launched the competition with FT and Hewitt called: “Managing pension funds as if the long term did matter”. This in turn became the Marathon Club, a group of investors looking at long-term investment issues. So I have to admit that I groaned a bit when my friends at The Conference Board asked me to help design an event on the theme. How many times can we have the same old conversation, I said! Indeed, in my darker moments, I think the very discussion serves the role of the confessional for repentant sinners who have no intent to change but who do like to feel better than the rest. Thankfully the Conference Board decided to go ahead. Interestingly, only one participant spoke against the position that things, in practice, hadn’t really moved forward since the last Conference Board event on this theme 5 years ago. But I believe things may be finally about to change. Partly it is because investment professionals are being more authentic today. In addition, hard-headed empirical research is illuminating the path ahead. For example, Mercer has just made a very thoughtful contribution to the debate about short-termism in the form of an empirical research project looking at what investment managers who claim to be long horizon investors actually do in practice. (see link at foot of article).Why do I find this study so interesting and useful? First, in a murky field based on claim and counter claim, the study’s conclusion, drawn from quantitative analysis of actual versus expected turnover rates and focusing solely on those portfolio managers who claim to be long-term, is clear: “There is a strong tendency for active (long-only) equity fund managers to have higher portfolio turnover rates than they claim”. The results speak for themselves: nearly two thirds of investment managers for whom Mercer has data exceeded their expected turnover by an average of 26% and in some cases as much as 200%. Second, a direct benefit of this study is that it proposes a methodology for assessing turnover that all clients, consultants and investment managers could choose to use. No methodology is perfect, but if we all use one approach – and it doesn’t matter which one we choose – we will have comparable results. Third, and beyond the result, this is one of the fist clear signs that consultants and academics (the study is sponsored by the new Investor Responsibility Research Center Institute) are grappling with the implications of not being able to anticipate future performance simply on the basis of past performance. The industry looks at ‘style’ factors, team, philosophy and approach to alpha generation. Could investment horizons now be added to this list? If so, they will be really lifting up the engine lid and looking into what contributes to performance and what are proxy
indicators which reassure, just as we in the Responsible Investor world seek to do with companies and their extra-financial drivers of risk and reward. Data compiled by Jack Bogle, founder of Vanguard, suggests there is preliminary evidence that high portfolio churn is correlated with weak investment performance. Fourth, some of the specific findings of the Mercer study are interesting. For example, value managers have, as might be expected, on average a lower turnover, but this is not uniform; indeed the diversity within the value category is as great as the difference between value and growth. The data also shows that Socially Responsible Investment (SRI) fund managers have, in general, lower turnover rates than non SRI (phew!). It also reveals a regional bias: US and continental EU (excluding UK) show higher turnovers than Canadian, Australian and UK strategies. What I found most interesting was the qualitative survey of fund managers. A third of those who were invited to participate declined! Since the study was going to be anonymous, i.e. there was no risk of penalties, why would fund managers decline the opportunity to shine with investment consultants? Anyway, the results were very telling: portfolio managers know what is wrong with the system but feel unable to take corrective action for the normal “tragedy of the commons” or collective agency reasons. Unprompted, the factors these portfolio managers raised were: volatile markets (but as Mercer points out, the spikes in turnover were very common before the crisis too) short-term traders and momentum investors driving a herd mentality, mixed signals from clients, short-term incentive systems within fund managers, and behaviour biases.So what is the cure? Rightly, in my opinion, Mercer acknowledges that there is no magic bullet for a system that is so interlocking and stuck. Intervention at all levels is needed. Interestingly, the report’s remedies start with “regulatory measures”. This is particularly noteworthy because the lead author has a long-standing anti-regulatory bias. Is it because the portfolio managers surveyed felt some kind of regulatory action was needed and that voluntary, best practice approaches would continue simply to fail?
Other proposed areas for action include changing the client relationship so that clients understand the costs of the current approach and are willing to support a longer-term approach where it is logical to do so (e.g. long-only mandates). The report’s final suggestion is a re-evaluation of “incentives/corporate culture”. The good news here is that this is within the control of the investment managers: i.e. they can act without client or regulatory action. As is the case for all research projects, this one also ends with a call for more research to dig deeper into the many remaining questions. Thankfully it doesn’t fall into the trap of advising a delay in action until this nirvana of complete understanding is reached. There are several “no regret” actions that could be implemented quickly by each of the links in the institutional investment chain. Hopefully the Conference Board will have an event in 5 years times when the story of changes in long-term investment will be very different.
Raj Thamotheram is a senior advisor, responsible investment at AXA Investment Managers.
Link to Mercer report