Mike was kind enough to write an open letter ahead of the debate entitled 'Dear George…' in which he has laid out some of his thinking on the subject. So I thought it would be polite to respond in kind. The two letters are probably best read in combination and Mike's original letter . Here is my response:
Thank you for your letter laying out your objections to the calls for ‘longer-term thinking’ that I, along with many other more eloquent writers, have articulated over recent years. Below I have tried to set out some of my response to your arguments:
First of all, I don’t really agree with your definition of long-termism or how you have framed this debate:
You have defined long-termism as being a vague concept, defined by calls to end quarterly reporting, implement longer-term mandates, extend stock holding periods and so on. Each of these does not define long-termism per se, but rather can be seen as symptoms of the problem. We have a culture that has developed over the last 30 years which values short-term gain over long-term reward, and there are a number of characteristics of the investment industry which reinforce that culture in an asset management context and combine to create short-term behaviours.
Long-termism is NOT the same thing as sustainable development. However, the most widely quoted definition of sustainability is that of the Brundtland Commission in 1987: “sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” So as a starting point, I think there is something of a commonality of agenda. You can be long-term without necessarily being sustainable (although long-term thinkers are much more likely to be inclined to think about sustainability) but you cannot be sustainable without being long-term.
Long-termism is perhaps best summarised by the contrast between two types of fund manager: those who believe the value of a share is the sum of the future cash flows (I’m going to call them Investors), and those that believe the value of a share is whatever someone else is prepared to pay for it (I’m going to call them Traders).
Within a functioning market, short-term traders can play a role, but I believe that:
• Such strategies have come to dominate the investment world – so the functioning of the market has become unbalanced.
• The claims over the role of trading strategies in providing liquidity are over-estimated.
• Too many investors are not transparent and are misleading about their approach, so that fund manager behaviour is not consistent with the marketing or sales message to clients.
• That ESG analysis is rendered irrelevant in short-term strategies.
• The short-term trade is a crowded one, and the mainstream investment industry is failing its clients – the average active manager is underperforming and has done for years.
• That the messages transmitted to the wider corporate sector as a result of the dominance of shorter term strategies work against the development of a sustainable economy.
As a result I believe that:
• Long-term investing is not only legitimate, but the only natural investment strategy for a sustainable investor and is likely to represent a competitive advantage.
• The path to a sustainable future can only be achieved by the vastly increased availability of finance that incentivises long-term investments and stewardship.
Long-term investing is NOT about:
• Avoiding transparency: You have written much about wanting to encourage more and better reporting. I support that and it is entirely consistent with a long-term agenda.
• Inactivity or delaying action, it is absolutely about enabling and catalysing a response today.
You can’t talk about the investment industry in isolation in this context without recognising where it sits in the value chain
For the purposes of this debate we are talking about the investment industry and, more specifically, the sustainable and responsible investment (SRI) industry. However, we would do well to remember our place in the value chain. We are an intermediary, an agent, through which finance is channelled from asset owners to the wider economy. Our role is to connect sources of capital to the consumers of capital in a productive and beneficial manner. You write that the long-term agenda is one that will get buried as the mainstream investment community pays lip-service to it. I would argue that it will be those in the mainstream that will be left behind. Many of the loudest voices in this wider debate are those who have most resource and the most sophisticated analysis within the asset owning community. Just look at BT Pension Service, Railpen and USS in the UK, and ABG, PGGM and FRR in Europe.
Our role is to earn a return for our clients in order to help them meet their own objectives or liabilities (which are almost always long-term), and we are also here to channel that investment capital into the economy in a productive manner. The impact of short-termism is failing the wider corporate economy. Investment projects are shelved to meet short term targets, costs are cut to the bone reducing resources that might not be noticed in the short term but at the expense of longer term healthy development, of companies, of the economy and of society.
There is an interesting challenge in your argument that investors should stick to investing and have no role in lobbying or regulating. I think that most SRI investors share a disquiet about the direction in which we are headed, and have chosen to express this through the way in which they approach their chosen career in financial services. It sets us apart from the caricature of the financial services industry as being purely out for self-gain without concern about the impact elsewhere. So yes, I do want to see wider change, I want to lay out what I see as the flaws in the system. Such a response is not confined to the SRI industry. When Warren Buffet described derivatives as being ‘weapons of mass destruction’ was he being a lobbyist or a regulator? No, he was telling it how he sees it, and talking his own book.
Long-termism is about strength, not weakness
I’m not sure why you argue that the long-termism debate is somehow used as an excuse for not being able to compete on performance. I could not disagree more. It is not as if the mainstream investment industry has really been delivering on its promises to investors. The City has become increasingly short term, and in doing so has become closer to the public caricature of the casino, it has become less sophisticated and failed to deliver investment returns. As a competitor and a selfish investor I welcome that fact that everyone else is so short term – it actually makes it easier for us to outperform. As Sir John Templeton wrote, "If you want to have a better performance than the crowd, you must do things differently from the crowd."
The short term trade is congested; everyone is trying to be the first to react to the next piece of news. It’s tough to find an information edge in this way now that information is so ubiquitous. Some end up lucky for a while, but most are whipsawed and underperforming. Think of some of the most celebrated names of the investment world - Buffet, Grantham, Templeton – and think of their average holding period. Neil Woodford has an average holding period of 6 years. Short termism is for those who don’t have courage in their convictions, views or processes to take a long term view, to be contrarian, or to buy the out of favour stocks. Short termism is for those who don’t want to stand aside from the crowd, and will end up running with the herd. It might take some bravery. It might take nerve to ride out some short-term periods of underperformance, but in general, our clients’ interests are served by what we can achieve in a much longer time frame. So yes, to use your words, this is all about winning the game. Play the short game if you will and you might win the odd battle, but the real investors will win the war.
Too much focus on timing and catalysts will help you lose sight of the wood for staring at the trees
‘Don’t deny me timing’, you write in bold capitals. You explain that you want to invest in the oil industry right up to the last second before the collapse, and then take out your short. The whole of the financial world tried this collectively during the last decade. “As long as the music is playing, you've got to get up and dance. We're still dancing” said Chuck Prince, CEO of Citigroup, in July 2007. It is analogous to driving your car as fast as you possibly can towards the cliff edge, and trying to time the moment at which you jump out to the very last second. However, bad the last five years of banking crisis have felt, the coming challenge will be of a much greater order of magnitude. I want to turn my car around and drive in a different direction altogether. The argument here is directly contradictory to your assertion elsewhere that you want to see “fast, disruptive change towards a ‘sustainable’ business environment,” and the suggestion that long-termism is somehow contrary to acting now. Quite the opposite, it enables an ‘act-now’ mind-set.
Some have called for the ending of quarterly reporting. Although I think that quarterly reporting might be a contributory cause of short-termism, I’m not sure that getting rid of it would reverse the trend. I am very much in favour of the trend towards greater transparency in corporate reporting and in general. More information should be a good thing. However, we need to find ways in which we can shift the focus away from the quarterly report being the end as of itself, towards its use as a marker on the road to a more significant destination. It is also worth remembering that, under the current model, the broking industry only gets paid if their client makes a trade… hence more information can just lead to more trading, and less investment.
Transparency is critically important, as I have argued elsewhere, and a significant problem remains the lack of openness within the investment industry. Too many investors try to convince their investors that they are ‘fundamental’ investors, but when you look at their average holding period it is less than a year. To me this is just misleading. Mercer’s 2010 study of active equity managers found that “nearly two thirds of institutional investor focused investment strategies exceeded their expected turnover.” Less than 10% had an average holding period of over three years. And the same goes for those who claim to be integrating ESG analysis but also turn their portfolios over on short time periods. Act like a trader, that’s fine, but don’t pretend that ESG is relevant to your process. It becomes meaningless. Whilst at Henderson, the SRI team’s analysis of BP in 2002 identified what we believed was a chronic level of under-investment within the business, a culture that would lead to repeatedly cutting costs and investment projects in order to meet quarterly targets. Did this mean that we could accurately predict at that time that several years later there would be disastrous accidents at Texas City or at Macondo? Of course not, but we could argue that this represented a fundamentally unacceptable level of risk to the long-term investment case which we acted upon. If we had then proceeded to trade in and out of BP shares 4 times a year on our view of what was going to be said in each quarter’s trading statement, it would have made a mockery of that analysis. Only over the longer term do ESG issues such as governance, risk, management quality, resource efficiency and so on become significant influences on share prices.
Long-termism is about a culture, a thought process. It doesn’t stop you from reacting quickly if the situation demands it, but come back to my original distinction: are you looking to establish the present value of the sum of the future cash-flows? Or are you putting on a trade or playing with the greater fool theory? It’s a dangerous game…
Paul Jackson, of Societe Generale Cross Asset Research wrote in Sept 2012: “The volatility of returns makes equity investing a form of Russian roulette if the time frame is too short – it is not until we go beyond three years that we can make sense of the task. It is also over these longer periods that simple valuation metrics have the greatest predictive power.”
I’m not sure if we are going to diverge further or end up agreeing!
Within the SRI Industry I think that the real battle in all of this is between those who feel that we just need to change a few of the inputs and that will be enough, the system works ok, it just needs a bit of fine tuning. For many of us, the financial system needs far more fundamental re-engineering. If this is our point of divide, I worry our positions may be irreconcilable.
However, although I’m a little confused, I’m also mildly encouraged by your final flourish. Long-termism is dead, you write, Long live (S)trategic and (R)esilient (I)nvestment! This does sound to me a lot like saying “long-termism is dead, long live long-termism.” So maybe there is yet a chance of reconciliation. I hope so.