The Imperative to Look Long
Six enormous government-owned investors announced on January 21 that they plan to support a new stock benchmark--the S&P Long-Term Value Creation (LTVC) Global Index. The question is why does the world need yet another such beast? Its creators say the new index will assess companies’ abilities to create long-term value, and use both qualitative and quantitative factors to do so.
More importantly, the Canadian Pension Plan Investment Board, Danish pension fund ATP, Singapore’s GIC, the New Zealand Superannuation Fund, the Ontario Teachers’ Pension Plan and Dutch pension manager PGGM, which have combined assets under management total over $1 trillion, agreed to put their money where their mouth is – committing to allocate about $2 billion to funds tracking the index.
Not excited? This might not have been the most exciting news of the week in which the World Economic Forum held its annual meeting in Davos and stock markets tumbled across the globe. But it is a big step illustrating that the world of finance is changing, and that the some of the world’s major asset owners are at the forefront.
The current financial turbulence, set against a background of sluggish growth, low interest rates and low yields has certainly served as an impetus. It has galvanised institutional investors to think about new ways to generate the income they need to fulfil their mandates – which generally have long-term liability and investment horizons.
Short-term world, long-term investors
For institutions that are looking to harness secular growth trends to generate returns over decades, today’s focus on quarterly reporting cycles and mark-to-market valuations is not only irrelevant. It can also be damaging.
Reporting huge paper losses that may never be realised can panic stakeholders, and encourage them to make short-term allocation decisions at odds with their long-term interests.
Sovereign savings, pension reserves and the largest public pension funds are looking for alternatives. The S&P LTVC Global Index seeks to commoditise quality investing – picking companies that have strong business models, disciplined management teams and low levels of leverage that can grow and preserve capital over long periods of time – traditionally the charge of far more-costly active managers. This strategy seeks to generate outperformance over the medium term and has lower volatility than the market. That helps reduce stakeholder anxiety.
But perhaps the most radical tack of these asset owners is the rethinking of the risks they are best suited to taking. Large public pensions in surplus and sovereign funds share two overarching characteristics: few or no immediate liabilities and enormous scale. That gives them the advantage of being able to bear illiquidity and to write large cheques.
So they can easily invest in an asset that may not bear fruit for years, perhaps for decades. As a result, many asset owners of this ilk have been working out how to integrate illiquidity into their asset allocation and risk models. They are looking to invest in real assets, such as infrastructure and real estate, or unlisted companies – both directly and through private equity funds.
Some have even taken substantial stakes in listed companies with the intention of holding those positions for many years. The longest-standing example is the Kuwait Investment Authority’s 5% stake in German automaker Daimler AG, which it has held since 1974.
But the Qatar Investment Authority has also taken this approach with companies including UK supermarket chain J Sainsbury’s, investment bank Credit Suisse and Volkswagen AG.
The last two instances highlight that while this approach offers rewards, it also carries substantial risks and requires skill and engagement to manage successfully. Due diligence regarding companies, assets and managers that are intended to generate income over many years requires a relatively scarce and expensive skill set that many public funds struggle to procure. Deriving value out of an illiquid investment also requires investors to be able to productively engage with the board and management--as a way to ensure that asset owners receive the maximum illiquidity premium.
Some funds have evolved into best-in-class asset managers: the Canadian pubic pension funds and sovereign funds like Singapore’s GIC or the Abu Dhabi Investment Authority are obvious examples. But others have struggled to generate value.
But even if these funds have struggled, they now have experience under their belts, and these institutions are now returning to managers with a better understanding of the investments and higher standards of service. Many are looking to work with fewer managers or a single manager who has the ability to take on large mandates. In return, managers will have to supply increasingly sophisticated value-added services such as strategic partnerships, insight, co-investment opportunities and ample access to portfolio managers.
With the shift in investment focus towards multi-decade returns, these institutional investors are focused on stewardship, governance and sustainability. Increasingly, these funds want to develop close relationships with co-investors and the management teams of their portfolio companies to ensure that the decisions they make are in all parties’ best long-term interest.
Increasingly, against the backdrop of the UN Sustainable Development Goals and the Paris Agreement signed at the 21st session of the UN Conference of Parties (COP21), investors need to have one eye on the environmental impact and carbon-intensity of those businesses in which they invest. They are even seeking out opportunities with companies that develop low-carbon infrastructure and technologies that will be central to a new environmentally sensitive economic paradigm.
A sea change
The announcement of the S&P LTVC Global Index may not have garnered many headlines. But it is emblematic of a fundamental shift in the way large institutional investors are putting their money to work.
This sea change is not just about the types of assets they invest in, the types of strategies they use or the risks that they take. It is a fundamental transition in the way that these institutions think about investing itself.
The emphasis is now on relationships, trust and responsibility in addition to performance. Some large investors have managed to persuade their stakeholders that this shift is in their best interests and are leading the way, while others still have work to do.Regardless, almost all institutional investors are beginning to understand that the future is not like the past. It will be fundamentally different. The opportunities that it presents will be different and the investment approach needed to harness the financial rewards is different too. And this is good news for long-term investors preparing for it.Volver al Instituto de Inversión