The purpose of investment is sustainable wealth creation. The output of which is long-term absolute returns for the providers of capital. But it also creates more and better jobs, innovation and better supply chains. It protects the environment and generates the productivity growth and tax revenues that underpin education, infrastructure and the welfare state.
The only way to create a society that works for the many, not just the few is to make the cake bigger and share it more fairly. And the only way that will ever be achieved is through long-term investment and hard work.
Set against these vital goals the financial services industry could hardly have set about creating a more dysfunctional model had it tried.
The investment chain, from the moment it leaves the pockets, pay packets and bank accounts of individuals to enter the capital markets, is travelling through a sausage machine where the primary driver of success is measured by short-term relative return.
Capital passes from individuals who are hard-wired with a propensity to be short-term and risk averse. It passes through an array of advisers and consultants, life companies and pension funds, investment managers and investment bankers, investment analysts and financial media.
Eventually, it is deployed by Boards and Chief Executives, hugely incentivised and massively pressurised to hit short-term targets and prioritise the short-term balance sheet over the optimisation of long-term cumulative returns derived from the sustainable success of the business.
In their February 2017 report, “Measuring the economic impact of short-termism” McKinsey & Co. found that:
- 87% of executives and directors feel most pressured to demonstrate strong financial performance within 2 years or less
- 65% of executives and directors say short-term pressure has increased over the past 5 years, and
- 55% of executives and directors at companies without a strong long-term culture say their company would delay a new project to hit quarterly targets even if it sacrificed some value
Ultimately, the aggregate impact of the capital market chain is leading companies to chop down the trees in their orchard because the value of the wood is greater than the value of this year’s apple harvest.
Many commentators point the finger of blame at asset owners. For example, McKinsey’s focusing capital on the long-term, says: “Until large asset owners radically change their approach, other key players (such as asset managers, corporate boards, and company executives) will probably remain trapped in value-destroying short-termism.”
This is true, but McKinsey is also wrong. Capital is transmitted through the markets via a chain of intermediaries and agents where no individual link has agency to change the chain on their own and where the chain is too strong to be reformed from the inside. The individual links are doing very nicely for themselves, there is plenty of long-term wealth creation for market participants and the chain is both wealthy and effective at lobbying against disruption.
The purpose of investment is not being fulfilled by the investment industry because focus on short-term relative returns damages long-term absolute returns. The consequences for beneficiaries and society are severe.
The tensile strength of the chain is why we need a revolution from the roots up.
- We need new investment funds that can operate outside the conventional capital market chain to be catalysts for change.
- We need funds whose managers have no external shareholders pressurising them for higher dividends every year.
- We need investors who have agreed to set time horizons well beyond three years and who will stick to it.
- We need investment managers who are relieved of the pressure to beat an index or a peer group over three years or less.
- And we need those managers to support, exhort or, if necessary, require Companies to act in ways that optimise long-term, sustainable wealth creation, even at the expense of maximising short-term returns.
The People’s Trust, which intends to list on the London Stock Exchange in October, aims to ensure that it can preserve the integrity of the purpose of investment. It intends to do this by creating its own chain, outside the conventional chain, that is impervious to short-term pressures from any source.
This clean chain incorporates:
- a bespoke structure for the vehicle, which owes no commercial entity its existence
- a clear seven-year performance measurement mandate focused on high-conviction investment with the object of sustainable wealth creation
- seven-year contracts for outstanding investment managers
- support for long-term strategies at investee companies to stand up to short-term pressure from other investors and capital market participants
There is no more important task than the reform of this chain, and there is no more direct way of making the world a better place than repurposing $100 trillion of investment capital globally towards sustainable wealth creation.