| Owning the Long Game
By: Linda-Eling Lee, Global Head of Research for MSCI ESG Research and
Matt Moscardi, Head of Sector Research for MSCI ESG Research
MSCI, Inc.
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| In 2017, some of the world’s largest investors may differentiate themselves by gearing toward the long view as globalization and technological advancements have strained social cohesion and fanned populist sentiment. This year may usher in a fundamental rethink for investors – do we change the way we think about investing, or is this business as usual in a new order?
In either case, one thing seems certain – focusing on policy shifts alone would be shortsighted. Policy is an outcome, forged by forces that unfold over more than one election cycle and reflect deeper technological, socio-demographic and energy trends that are reshuffling the social order and the investment landscape. Highlighted in their recent paper: 2017 ESG Trends to Watch, MSCI identifies the notion of “Owning the Long Game” as one of the biggest Environmental, Social and Governance (ESG) forces affecting institutional investors over the long haul.
The outset of 2017 marks an inflection point for institutions that purport to invest for the long term. Globalization and technological progress have produced both prosperity and inequality over many decades.1 Since the global financial crisis, a growing chorus of investors and policymakers has railed against short-termism and advocated taking a long view.2 With more upcoming elections showing potential signs of populist political shifts, the temptation will be to react and over-react to spasms in the Twittersphere. But what 2016 taught us is that it’s the slow-burning risks that can matter the most.
Exogenous risk, like regulatory shifts or a rise in sea levels, can be a source of excess return for institutional investors as companies position themselves to innovate and adapt – or see their business models vanish. For a universal, long-term investor,3 however, all risk is endogenous. Consider corporate tax payments, which perennially garner headlines when companies fail to pay their “fair share” of taxes. While corporations can, at a firm level, reap rewards from tax arbitrage, the wholesale impact includes gaps in funding for needs such as infrastructure and health care, while raising the risk of regime change that can upend the competitive dynamics and profitability of entire sectors. Long-term investors cannot afford to collect the short-term gains at the expense of crumbling infrastructure. They own both outcomes. In recent years, long-term institutional investors have started to manage these economy-wide risks through collaborative engagements that aim to shore up market standards in areas ranging from corporate governance to climate risk.4
Some are ready to go further and position themselves differently from a market dominated by short-termism. We see two approaches on the horizon. The first is an investment policy shift that emphasizes the long term by adopting benchmarks that explicitly incorporate views of the future. While market capitalization-weighted benchmarks best reflect today’s market value and opportunity set, long-term investors currently lack a way to proactively assert their beliefs about how markets will look years from now as risks from climate change or social inequality are eventually priced by the market. While the differences may be subtle, entailing, for example, a slight tilt towards more resilient assets, a shift from “reflect” to “assert” may allow institutional investors to look beyond blind spots that can come with a focus on the short term.
If the first approach is a change in policy, the second is a change in action. Buoyed by a slew of research since the financial crisis that focuses on a mismatch of incentives,5 long-term investors are more likely to focus on generating excess return through strategies that aim to assemble a portfolio of so-called high-conviction picks6 with limited turnover.
An example of this type of long term approach, some research published in 20167 highlighted how fundamental metrics, such as dividend growth, contributed more to active returns as time horizon was lengthened. Additionally, the value leakage that a misalignment of incentives, a lack of accountability, or exposure to long-term risks such as climate change can produce lends to a strategy that emphasizes vigilance and influence; in short, for investing with the mindset of an owner rather than a trader.
The year ahead has the potential to test institutions and portfolio companies that espouse a long-term orientation. The temptation to time the market in response to (or in anticipation of) events – real or rumored – could prove too powerful a distraction for many. But for investors committed to the long term, 2017 may be the year to differentiate themselves from the pack and orient towards future decades.
For further information on this topic, please contact any of the professionals at DiMeo Schneider & Associates, L.L.C.
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| 1 See for example Autor, Dorn & Hanson. 2013. NBER Working Paper. “Untangling Trade and Technology: Evidence from Local Labor Markets” and Chandy & Dervis. 2016. Brookings. “11 Global Debates: Are Technology and Globalization Destined to Drive Up Inequality.”
2 See, for example, “The Kay Review of UK Equity Markets and Long-Term Decision Making.” Also Haldane, 2015. Speech at University of Edinburgh Corporate Finance Conference. ”Who Owns a Company?”
3 “Universal owners” include large institutional investors such as pension funds, sovereign wealth funds and endowments – that are large enough to own every asset class and thus be exposed to the entire market. They typically have liabilities that stretch decades. See for example Hawley and Williams. 2006. The Rise of Fiduciary Capitalism: How Institutional Investors Can Make Corporate America More Democratic.
4 We highlighted an increase in what we have called a beta engagement strategy in our 2016 ESG Trends to Watch. In order to shift the market – in effect, “manage” their beta, some institutional investors are taking on issues wholesale as a complement to their traditional approach of engaging one company at a time. The movement to bring shareholders in the U.S. a right of proxy access enjoyed already by investors throughout Europe is the most prominent and successful example to date of ”beta engagement.” Another example is a campaign led by the Coalition for Environmentally Responsible Economies (CERES) that focuses on the filing of resolutions that urge fossil-fuel-based companies to stress test their business strategies in a scenario of where global warming is limited to 2⁰ Celsius
5 See for example Investment Leaders Group. 2016. ”Taking the Long View: A Toolkit for Long-Term Sustainable Investment Mandate; Focusing Capital on the Long Term.” 2015. ”Long Term Portfolio Guide”; Center for International Finance and Regulation Research Working Paper Series. 2014. ”Benefits (and Pitfalls) of Long Term Investing,” ”Long-Term Investing: What Determines Investment Horizon?”
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| About the Authors
Matt Moscardi currently serves as Head of Sector Research for MSCI ESG Research. He leads a team of five analysts across Europe and Asia dedicated to the financial sector, and Matt is responsible for ESG ratings methodology and trends analysis across the sector for MSCI’s core ESG products. Prior to that, Matt worked directly on ESG ratings in the financial sector and served as Chair of the ESG Editorial Board.
Prior to joining MSCI, Matt developed low-carbon investment programs and engaged directly with US pension funds and asset managers managing over USD 10 trillion in assets as a Manager at Ceres, a Boston-based non-profit. Matt also founded a hedge fund with a sustainability and resource scarcity theme, managing less the USD 1 million, before joining Ceres. He is a graduate of Brown University with a concentration in Computers and Music.
Linda-Eling Lee currently serves as the Global Head of Research for MSCI’s ESG Research group. Linda-Eling Lee oversees all ESG-related content and methodology and chairs MSCI’s ESG Ratings Review Committee. She leads one of the largest teams of research analysts in the world who are dedicated to identifying risks and opportunities arising from material ESG issues. The team, located in 12 offices globally, provides ESG ratings of 5,000+ issuers; industry and thematic research; and analysis used by investors for positive and negative screening.
Linda joined MSCI in 2010 following the acquisition of RiskMetrics, where she led ESG ratings research and was head of consumer sector analysis. Linda joined RiskMetrics Group in 2009 through the acquisition of Innovest. Prior to joining Innovest, Linda was the Research Director at the Center for Research on Corporate Performance, developing academic research at Harvard Business School into management tools to drive long-term corporate performance. Previously, she was a strategy consultant with Monitor Group in Europe and in Asia, where she worked with Fortune 500 clients in industries ranging from beverages to telecommunications.
Linda received her AB from Harvard, MSt from Oxford, and PhD in Organizational Behavior from Harvard University. Linda has published research both in management journals such as the Harvard Business Review and MIT’s Sloan Management Review, as well as in top academic peer-reviewed journals such as Management Science and Journal of Organizational Behavior.
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| While this article addresses generally held investment philosophies of DiMeo Schneider & Associates, L.L.C., it does not represent a specific investment recommendation for any individual client or prospective client. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice.
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| This report is intended for the exclusive use of clients or prospective clients of DiMeo Schneider & Associates, L.L.C. Content is privileged and confidential. Any dissemination or distribution is strictly prohibited. Information has been obtained from a variety of sources believed to be reliable though not independently verified. Any forecasts represent median expectations and actual returns, volatilities and correlations will differ from forecasts. Past performance does not indicate future performance.
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