Investing Because The Long Term Matters

Can Finland Set The Benchmark?

Dr Raj Thamotheram (with thanks to Tim MacDonald) Finsif sysseminaari 28.10.13

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Another narrative!2

Can Finland lead?

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Can Finland lead?

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Can Finland lead?

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Can Finland lead?

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Can Finland lead?

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Can Finland lead?

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Can Finland lead?

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Can Finland lead?

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Can Finland lead?

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Short-termism isnt working!

For end beneficiaries

For companies

For economies

For biodiversity or future generations

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End beneficiaries are hurting

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“....rethinking the purpose of current solvency regulations would make it possible to devote a larger proportion of Finnish pension asset to long-horizon, return-seeking strategies, thus raising the expected return on investments.”

Keith Ambachtsheer

Evaluation of the Finnish Pension System, Finnish Centre for Pensions (2013)

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Is  so  much  hedging  of  short-­‐term  solvency  risk  really  needed?

Could  funds  take  a  more  robust  long-­‐horizon  investment  view?

Are  ac=ve  equity  strategies  as  light  in  “beauty  contest”  inves=ng  as  they  could  be?

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11 fatalities 17 injuries

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11 fatalities 17 injuries

Latest BP cost estimate $40 billion 30% share price drop1-year suspension of dividends

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The dominant narrative = blame someone else!

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The dominant narrative = blame someone else!

“an Act of God” Rick Perry, Governor of Texas

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The dominant narrative = blame someone else!

“I left BP a long time ago, four years”

Lord Browne

“an Act of God” Rick Perry, Governor of Texas

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The dominant narrative = blame someone else!

"It's very dangerous to join up dots that may not be appropriate to join up"

Tony Hayward

“I left BP a long time ago, four years”

Lord Browne

“an Act of God” Rick Perry, Governor of Texas

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The dots that we shouldn’t join up….

Source:  Yahoofinance.com  

TexasRefineryAccident

TexasRefineryAccident

AlaskaOil

Spill

AzerbaijanGas leak

ViolationsOf CleanWater Act

PenaltiesFrom the

OSHA

Gulf ofMexicoOil spillThunder

HorseAccident

Charges forManipulation

Of gasmarket

Grangemouth2000

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The dots that we shouldn’t join up….

Source:  Yahoofinance.com  

TexasRefineryAccident

TexasRefineryAccident

AlaskaOil

Spill

AzerbaijanGas leak

ViolationsOf CleanWater Act

PenaltiesFrom the

OSHA

Gulf ofMexicoOil spillThunder

HorseAccident

Charges forManipulation

Of gasmarket

Grangemouth2000

“Up  un'l  April  19,  his  performance  was  excellent.”

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How much attention did “sell-side” pay to safety?

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7.50

15.00

22.50

30.00

“Hea

lth”

“Safe

ty”“F

ine”

"Pen

alties

"“S

pill”

“Injur

y”

"Incid

ent" o

r "ac

ciden

t"

“Fata

lity” o

r "de

ath"

"OSHA"

"Bak

er"

Total

numbe

r of o

ccure

nces

Occurences of keywordsO

ccur

ence

s

2005 - August 2010 (post GoM included) 2005 - April 2010 (post GoM not included)

Before  the  oil  spill,  6 occurrences every 100 pages  =  the  vast  majority  of  reports  do not  talk  about  these  risks  at all.

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Behavioural finance expert: “analysts are biased”

n Unicredit: analysts claim that BP has a good operational momentum because of its “first-mover advantage in cost cutting”

5  =  buy  or  strong  buy  recommenda2ons4  =  add,  overweight,  outperform  and  accumulate3  =  hold,  perform,  neutral2  =  reduce,  underweight  and  underperform1  =  sell  or  strong  sell

Source: SHEFRIN Hersh, CERVELLATI Enrico Maria, “BP’s failure to debias: underscoring the importance of behavioral corporate finance”, 21st February 2011

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Economies are becoming more dysfunctional

CFOs will trade off practically everything to protect the quarterly number

More bubbles, more damaging

Kay Review: investors are driving corporate short-termism

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The global situation is clear …unless you are in denial

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The global situation is clear …unless you are in denial

The ‘Perfect Storm’(UK Government Chief Scientist,

John Beddington, 2009)

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“The hallmarks of tomorrow’s world will be scarcity – of

land, oil, food and ‘air-space’ (for greenhouse

gases)”

US NIC, 2008

The global situation is clear …unless you are in denial

The ‘Perfect Storm’(UK Government Chief Scientist,

John Beddington, 2009)

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“The hallmarks of tomorrow’s world will be scarcity – of

land, oil, food and ‘air-space’ (for greenhouse

gases)”

US NIC, 2008

The global situation is clear …unless you are in denial

The ‘Perfect Storm’(UK Government Chief Scientist,

John Beddington, 2009)

[Climate change risk] “should compel all elected leaders to take immediate action”

Mayor Bloomberg, 2012

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What’s gone wrong?

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What’s gone wrong?

Investors are neither evil nor the sole culprits, rather we are co-creating this mess

Theory (MPT), codified in law (fiduciary duty) acts as a liabilty shield AND a straight jacket

Outcome = misaligned rewards + externalised costs + systemic risk

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The Way Forward?

Focus on the PURPOSE of pension funds!

Match assets with very LT liabilities in a way which values inter-generational fairness and is based on good economic/scientific/common sense

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Five priorities

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Five priorities

Address “Preventable Surprises” (eg stranded assets) - valuation and stewardship

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Five priorities

Address “Preventable Surprises” (eg stranded assets) - valuation and stewardship

Embrace Integrated Reporting (investors too!)

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Five priorities

Address “Preventable Surprises” (eg stranded assets) - valuation and stewardship

Embrace Integrated Reporting (investors too!)

Fundamentally re-think pay, incentives, time-periods, clawbacks

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Five priorities

Address “Preventable Surprises” (eg stranded assets) - valuation and stewardship

Embrace Integrated Reporting (investors too!)

Fundamentally re-think pay, incentives, time-periods, clawbacks

Engage in public policy and challenge anti-social corporations

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Five priorities

Address “Preventable Surprises” (eg stranded assets) - valuation and stewardship

Embrace Integrated Reporting (investors too!)

Fundamentally re-think pay, incentives, time-periods, clawbacks

Engage in public policy and challenge anti-social corporations

INNOVATE new investment forms

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Sharan Burrow of the International Trade Union Confederation has it right with her call to “hit the re-set button”

Suzanne Lynne Duncan of State Street Research documents what’s wrong with her “Influential Investor”

Keith Ambachtsheer of International Center for Pension Management says “The window to mount an R+D project to assess how to best do this may now be open.”

Paul Woolley, Jeremy Grantham, Jon Lukomnik, John Fullerton...

New international best practices are emerging!

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How can Finland be the first to act?

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Pensions have

scale

purpose

longevity

POWER

Starting Assumptions

Yes, they can trade, but what else can

they do?

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Negotiate

Real Estate

Energy

Infrastructure

Private Equity

Let’s assume we want to make PE more like RE,i.e. we want to make it

Evergreen.

How can we do that?

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What is Evergreen?Evergreen is a form of investment that enables long-term investors such as pension funds to share in the cash flows of mature stable businesses.

Financial returns are earned through these planned cash distributions, rather than through a hoped-for sale of the stock at a higher price than originally purchased.

In addition, interests can be truly aligned, with values negotiated into the sharing formulas, up front.

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How does it differ from traditional private equity

Traditional PE Evergreen PEtargets underperforming companies for transformational turnaround through a time-out from trading,

targets healthy, market-leading companies generating robust and

enduring cash flows for permanent exit from the trading markets

seeks to profit by increasing enterprise value which they realize

by selling that enterprise

seeks to share directly in cash flows currently being generated by proven

enterprise leaders

requires a compressed timeframe within which to complete the

required transformation and effect the required exit-by-sale

just keeps going, sharing in cash flows as earned to support ongoing

liabilities to retirees across the generations

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Evergreen Investor

Mechanical Investors Traders

Deep understanding of sector Algorithm (incl index) Makes bets

More likely to support management thru’ ST

volatility

Supporting/not supporting management

is irrelevant

Interested in earlier access to better news

20% 30% 35%

4-10 positions 100-150 positions 20 positions

Adapted from McKinsey & Co (“Communicating with the right investors”, Spring 2008)

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40%

20%

40%

Short-horizon active managementLong-horizon wealth creating Liability-hedging management

Innovating a new balance

“Institutional investors, led by pension funds, must continue to build and support dedicated, non-conflicted, special-purpose entities that translate good theory and empirical research into actionable strategies that consciously promote long-horizon wealth-creation.”

Keith AmbachtsheerThe Ambachtsheer Letter

October 2013

^

Finnish?40%

20%

40%

Short-horizon active managementLong-horizon wealth creating Liability-hedging management

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The safety analogy - investors can do the same!

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The Audience We Need to Convince27

The Audience We Need to Convince27

people who want things to continue

as they are

The Audience We Need to Convince27

people who want things to continue

as they arepeople who want to make a change

The Audience We Need to Convince27

people who want things to continue

as they arepeople who want to make a changepeople who just

want to do the right thing, right

The Audience We Need to Convince27

people who want to make a changepeople who just

want to do the right thing, right

The Audience We Need to Convince27

people who want to make a changepeople who just

want to do the right thing, right

The Audience We Need to Convince27

people who want to make a changepeople who just

want to do the right thing, right

The Audience We Need to Convince27

half look backward, to what is being done

people who want to make a changepeople who just

want to do the right thing, right

The Audience We Need to Convince27

half look backward, to what is being done

people who want to make a changepeople who just

want to do the right thing, right

The Audience We Need to Convince27

half look backward, to what is being done

half look forward, to what is can and should

be done

people who want to make a changepeople who just

want to do the right thing, right

The Audience We Need to Convince27

half look backward, to what is being done

half look forward, to what is can and should

be done

people who want to make a changepeople who just

want to do the right thing, right

ESG2.0 can pull the forward-looking half forward, to see the possibilities through the

window of R&D

The Audience We Need to Convince27

half look backward, to what is being done

half look forward, to what is can and should

be done

people who want to make a changepeople who just

want to do the right thing, right

ESG2.0 can pull the forward-looking half forward, to see the possibilities through the

window of R&D

The Audience We Need to Convince27

half look backward, to what is being done

half look forward, to what is can and should

be done

people who want to make a changepeople who just

want to do the right thing, right

ESG2.0 can pull the forward-looking half forward, to see the possibilities through the

window of R&D

The Audience We Need to Convince27

We all matter!

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We all matter! Yes YOU!

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We all matter! Yes YOU!

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We all matter!

Identify & empower the outliers who have the potential to succeed despite the odds (“Positive Deviants”)

Yes YOU!

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We all matter!

Identify & empower the outliers who have the potential to succeed despite the odds (“Positive Deviants”)

Act on what we already know is right (“Giving Voice to Values”)

Yes YOU!

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We all matter!

Identify & empower the outliers who have the potential to succeed despite the odds (“Positive Deviants”)

Act on what we already know is right (“Giving Voice to Values”)

When a critical mass of “bystanders” get off the fence, the team/company/sector will “tip”

Yes YOU!

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We all matter!

Identify & empower the outliers who have the potential to succeed despite the odds (“Positive Deviants”)

Act on what we already know is right (“Giving Voice to Values”)

When a critical mass of “bystanders” get off the fence, the team/company/sector will “tip”

Develop collaborative solutions to reduce free-rider/first mover disadvantage

Yes YOU!

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