Recent geopolitical turmoil and weaker-than-expected corporate earnings can quickly turn market sentiment negative and bring our focus too much into the "here and now." With that, we risk losing track of long-term value creation and sustainable profit growth. Inevitably, focusing the attention on short-term factors tends to disregard long-term outcomes. But what lessons can we learn beyond the world of fast money movers?
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By putting too much emphasis on short-term returns, investors contribute to what Dominic Barton at McKinsey calls "quarterly capitalism," casting a negative influence on a company's strategy. In Barton's 2011 article "Capitalism for the Long Term," he expresses that short-termism in modern business lies at the heart of many of our problems. One year later, economist John Kay published the conclusions of his "Kay Review of UK Equity Markets and Long-term Decision Making." One of his key recommendations was the creation of an Investor Forum with the view to facilitate engagement between investors and companies, ultimately supporting long-term value creation. This new body was finally launched in July, chaired by Simon Fraser, current chair of Foreign & Colonial Investment Trust and former CIO of Fidelity Worldwide Investment.
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Investing for the long term seeks to align horizons of investors with long business cycles. In June 2014, Nasdaq OMX Advisory Services polled 21 investment professionals globally, trying to establish an ideal investment horizon for a typical long-term investor. Four in five interviewees agreed that long-term investors should have an investment horizon of at least five years in their portfolios, while nearly two in five preferred an even larger timeframe of at least 10 years.
The results of our survey reiterated the general perception that investors' short-termism had not improved since the financial crisis, with only 14 percent believing average investment horizon to have increased since the 2008 financial crisis.
The impact of high-frequency trading (HFT) globally has clearly reinforced this negative perception. Not surprisingly, the additional trading activity carried out has resulted in a shortening of the average length of time stocks are held for. And yet, the investment community should not forget that the traditional institutional investor continues to be the key influencer on business behavior.
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It is precisely outside the HFT space where a fascinating new trend is emerging. Contrary to what our panel would have expected, the ownership study on more than 8,000 investors based worldwide carried out by Nasdaq OMX indicates that investor turnover has been consistently decreasing since the financial crisis. More than one-in-three U.S. dollars invested by asset managers is currently held in portfolios with very low turnover rates indicative of average holding periods of five years or longer; nearly three times the levels seen back in 2008.
A key factor contributing to this decrease in stock turnover could be the adoption of sustainable and responsible investment (SRI) practices by a growing number of investors. The integration of Environmental, Social and Governance (ESG) factors in their decision making, championed by the United Nations-sponsored Principles for Responsible Investment (UNPRI), generally implies taking a long-term investment approach. Our research indicates that the portfolio turnover of SRI investors is on average 20 percent lower than that of mainstream investors. Dutch pension managers APG and PGGM alongside U.K. ethical investor CCLA are low-turnover leaders outperforming the benchmark by more than 50 percent.
The noticeable resurgence of long-term investors means that short-termism is no longer the dominant approach it once represented; yet our survey reveals a high degree of consensus among its participants on additional policy changes which could further boost this trend towards long-termism.
First, asset owners need to establish long-term investment mandates to strengthen returns. This would give asset managers more flexibility to invest without being penalized for deviating from short-term performance benchmarks. Similarly, retail funds should increase their investment horizon. Lastly, executive pay needs to remain aligned with long-term objectives. Fidelity Worldwide Investment CIO Dominic Rossi recently demanded companies ban bosses cashing in bonus shares for at least five years; the firm has voted against remuneration proposals for more than half of FTSE 350 companies it voted on during 2014.
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This new investor mindset creates an unprecedented opportunity for businesses to refocus their strategy. By shifting their attention from quarterly earnings to long-term innovation targets, improving operational efficiency and lessening their overall environmental impact, businesses can become truly sustainable and be better placed to attract investors for the long haul. Increasing the presence of low-turnover and SRI investors in the shareholder base will naturally result in lower stock price volatility. We're already seeing this in companies such as Unilever and Google.
Commentary by Miguel Santisteve, an associate director of advisory services at Nasdaq OMX, based in London. He focuses on responsible investment and Environmental, Social and Governance insights for investor relations.