Thursday, March 12, 2015

Focusing Capital on the Long Term?

David Benoit of the Wall Street Journal's MoneyBeat reports, BlackRock’s Fink, McKinsey Lead Group Fighting Wall Street Myopia:
A group of executives and investors sought the answer to the “scourge” of short-term thinking on Wall Street, Washington and across businesses in a New York conference room overlooking Central Park on Tuesday.

The group, calling itself Focusing Capital on the Long Term, batted around ideas on what concrete steps they and their powerful organizations can take to give executives breathing room to make the kinds of decisions that may drive growth down the road but might also draw flak from investors wondering about the here and now.

Among the steps discussed were changing compensation for both corporations and fund managers and about how to improve dialogue between both sides.

What exactly the group concluded in their closed-door meeting hasn’t yet been announced. It plans to release more specifics, but in interviews, the co-chairs portrayed the forum as a first step toward implementing goals that are still being ironed out. The co-chairs acknowledged they need to convince players that their solutions can actually help even.

“The most important concrete step was bringing greater awareness,” said Laurence Fink, the head of BlackRock Inc. and one of the co-chairs.

Among the topics Mr. Fink raised at the meeting, he said, was whether changes should be made to the definition of fiduciary duty – the requirement that investment managers are beholden to seek to grow their clients’ money above all else. Mr. Fink wanted discussion about whether the definition could expand to give leeway to fund managers to think about topics like job creation or the environment when making decisions. He said he didn’t know the answer.

Dominic Barton, a managing director at McKinsey & Co. and a fellow co-chair, said one CEO (names were carefully guarded) captivated the group’s imagination when he admitted his pay structure would actually allow him to make more in a few years than his whole career by eliminating research and development spending and instead buying back stock. The company wouldn’t exist after 10 years, the CEO added.

That fits with the group’s call to arms, a study conducted by McKinsey and the Canadian Pension Plan Investment Board, or CPPIB, in late 2013. The study found 63% of executives felt short-term pressure was increasing. And, most memorably to the group, a majority wouldn’t be willing to make an investment to increase their profits by 10% over three years if it meant missing quarterly earnings. The group has labelled this the “scourge” of short-term thinking.

Mark Wiseman, the CEO of CPPIB and the third co-chair, said the forum’s intention was to bring together investors and executives who actually make decisions.

Among those there were Andrew Liveris, the CEO of Dow Chemical Co., Steve Schwarzman, CEO of Blackstone Group LP, Randall Stephenson, CEO of AT&T Inc., and Eric Cantor, the former congressman now at Moelis & Co.

Treasury Secretary Jacob Lew discussed his hopes to reform the tax code and support infrastructure spending in order to help businesses grow.

While the group aims at loftier goals, its message counteracts growing pressures from some investors like activists, who the group tends to frown upon. (Mr. Fink has publicly said activists are hurting the economy.)

Mr. Wiseman and Mr. Fink said activists are taking advantage of the void that’s been left by institutional investors, and that the group is looking to fix that by fostering more dialogue between boards and those who drive longer-term growth.

“To me, the fact a holder of 1% of the stock can have that amount of influence [means] shame on the other 99%,” Mr. Wiseman said of activists.

Mr. Lew was asked to address whether activism has gone too far, but delivered the kind of non-answer the group will need to overcome from its own members in order to actually create change.

“I don’t think you can dismiss either short-term or long-term,” Mr. Lew said. “If you are a steward of a company, your responsibility is for both.”
McKinsey just published their quarterly insight, Perspectives on the Long Term, going over what it will take to shift markets and companies away from a short-term way of thinking. The study cited in the article above can be found here.

Forgive my skepticism but while these conferences bring together some powerful industry titans, the reality is the constant pressure to deliver short-term results will only intensify unless corporate America addresses a compensation system run amok.

As far as activists are concerned, everyone publicly frowns upon them, but privately many pension funds are all too happy to see activists doing their thing, especially if it means higher share prices for everyone. Carl Icahn may be thinking myopically when he's urging Apple to buy back its shares but if it means higher share prices for the world's largest company by market cap, everyone stays silent. At the end of the day, investment funds are looking out for performance, short-term performance.

And the sad reality is that pensions, which make up the bulk of so-called patient capital touting the long, long view, are guilty of the same short-term thinking that they supposedly want to combat. Pension360 just posted an interesting comment on a study examining herd mentality in pensions:
Pension funds exhibit a herd mentality when formulating investment strategies, according to a new paper that studied the investment decisions of UK pension funds over the last 25 years.

The paper, authored by David P. Blake, Lucio Sarno and Gabriele Zinna, claims that pension funds “display strong herding behavior” when making asset allocation decisions.

More on the paper’s conclusions, from ai-cio.com:
According to the study, there was overwhelming evidence of “reputational herding” behavior from pension funds—more so than individual investors.

Pension funds are often evaluated and compared to each other in performance, the paper said, creating a “fear of relative underperformance” that lead to asset owners picking the same asset mix, managers, and even stocks.

Data showed herding was most evident at the asset class level, with pension funds following others out of equities and into bonds at the same time. They were also likely to herd around the average fund manager producing the median return—or a “closet index matcher.”
The paper can be found here.
It's about time academics publish research on something which I've been covering for years on this blog, namely, that pension funds exhibit severe herding behavior going to the same conferences, listening to the same useless investment consultants shoving them in the same brand name funds and listening to brokers recommending a new asset allocation tipping point which generates huge fees for their big hedge fund and private equity clients, but milks public pensions dry.

But wait, aren't private equity funds now following Warren Buffett's long-term approach? Nope, that's all nonsense to garner more assets and fees from underfunded pensions desperate for yield. The Oracle of Omaha has warned pensions to stop pouring money into expensive money managers and so has George Soros who rightly notes most hedge funds aren't worth the fees they're charging and most pensions should avoid them altogether (interestingly,  CalPERS expects to pay 8 percent less next year for external money managers as it liquidates its hedge-fund program).

It's hardly surprising then to see pensions like HOOPP which think independently and don't follow the crowd, delivering outsized gains for their members and more importantly, keeping their plan fully funded. HOOPP basically takes the opposite side of the consensus pension fund allocation and uses smart tactical alpha to add gains to this allocation.

And while we're on the topic of short-term thinking and compensation run amok, I think Canada's public pensions should lead by example, cutting the bloated compensation of their senior executives which is based on value-added over (mostly) bogus benchmarks in private markets designed to game a system that allows them to make multimillions based on four-year rolling returns on money they're managing on behalf of captive clients.

That last paragraph won't win me a lot of support from many senior pension fund executives in Canada, some of whom subscribe(d) to this blog but that's fine by me. I have publicly stated we need to scrutinize compensation at some of Canada's large public pensions and see if there are abusive practices going on there.

As far as corporate America, CEO pay is spinning out of control, and it will continue to get worse until the next crisis hits and there is a real effort to rein it in. That system is rigged too as the Fed's policies have generated massive inequality, liquidity and record profits, allowing Fortune 500 companies to buy back their shares to 'generate more value' for their shareholders and more importantly, to boost their increasing and insanely bloated compensation system for their senior executives.

Winston Churchill once famously quipped: "Democracy is the worst form of government, except for all those other forms that have been tried from time to time." I can say the same about capitalism, it's the worst economic system except for all other forms that have been tried from time to time.

This leads me to recommend policymakers around the world pass laws forcing private and public organizations, including public pensions, to publicly state the ratio of their CEO and senior executives' compensation relative to the median and average compensation at their organization. It should be stated in black and white in their annual report even if they don't publish data on specific individual compensation.

What else do I recommend? That we start compensating public pension fund managers on real value-added based on benchmarks that reflect the beta, leverage and illiquidity risks they're taking and compensate them based on ten-year rolling returns. We should also cap the compensation of senior executives at Canada's large public pensions to reflect the fact that they're public pensions which manage money from captive clients (admittedly, I don't like capping comp but it's obvious the status quo will only lead to more public outcry, especially in socialist Canada).

We live in an age of austerity for most people. Teachers, police officers, firemen, public sector workers, and even doctors are now facing drastic budget cuts, so why aren't we scrutinizing the compensation at Canada's large public pensions? Pay for performance, no problem, but make sure it's real performance not leveraged beta, and make sure the compensation system at Canadian public pensions reflects the risks these managers take and the fact that they're in an advantageous position of managing billions from captive clients.

Again, some of you will disagree with my comments above. If you feel strongly that I'm not properly covering the topics of compensation at Canadian pensions or the fact that pensions calling for long-term thinking are themselves guilty of short-term herding behavior, then by all means reach out to me via email (LKolivakis@gmail.com) and I'll be happy to post your feedback.

On that note, I've got to get back to doing what I love most, swing trading and focusing on markets. I don't have the luxury of making multimillions based on four-year rolling returns beating bogus private market benchmarks. I've got to survive by eating what I kill in these crazy, volatile schizoid markets dominated by short-term high-frequency algorithmic and momentum traders. But rest assured I'm taking the opposite side of the pension consensus trade and loving every minute of it. :)

Those of you who have subscribed to this blog, a friendly reminder that it's time to re-subscribe and show your appreciation for my tireless work in bringing you the very best insights on pensions and investments in the world. Unlike the pension herd worried about career and reputation risk, I'm sticking my neck out day in and day, providing you with much needed critical thinking. Please show your support by donating or subscribing via PayPal on the upper right-hand side.

Below, Mark Wiseman, CEO of CPPIB, talks about the FCLT initiative - and the reasons that long term investing is needed, and how we can get there. More videos will be posted on YouTube here.

And Dennis T. Whalen, Executive Director and Partner in Charge, KPMG's Audit Committee Institute, shares some key takeaways from KPMG's Spring 2014 Roundtable Series. Read the full report here.


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