Several weeks ago, while visiting with an advisor to CEOs of the world’s largest companies, a question came up that startled me: What exactly are asset owners, and how do these institutions participate in deciding how companies are run?
Very few people outside the industry know that pensions, sovereign wealth funds, central banks, endowments, and foundations control most of the capital that funds asset managers, which then turn around and invest in companies. But I took for granted that the CEOs of global corporations were closely familiar with the asset owners that form so much of their capital base.
Even though it caught me off guard, it is a very reasonable question to ask. The bigger issue is what the question represents.
CEOs have long claimed that the relationship between companies and their investors is vital to creating value. This relationship, combined with long holding periods, is what distinguishes investing in businesses from just “trading paper.” Yet if corporate CEOs commonly do not understand the asset owner community or how these institutions participate in corporate governance, it makes claims of a valuable relationship hard to believe.
Indeed, many executives from asset owners and public companies confidentially acknowledge that they struggle to generate real value, including long-term returns, from their relationships. Meanwhile, asset owners have put a record amount of money into private-market investments, according to a McKinsey & Co. analysis of Prequin data.
These two patterns — higher private-market allocations and seemingly less productive public-market relationships — may be correlated rather than coincidental. They point to a difficult choice for executives: work on developing relationships with public companies or take their capital and businesses private so they can engage more easily.
Continuing with the status quo is not an option. Financial return remains essential, but it is no longer sufficient. Powerful long-term trends are permanently changing the opportunities and challenges of capital markets and require leadership from asset owners and corporate executives.
Most prominent is the existential imperative to remove carbon from the atmosphere — which has to come from business operations. Societies around the world also are demanding that local investors and local companies perform for them at home before they go international — and that they do so in a way that includes women, ethnic minorities, indigenous populations, and people of color more broadly. Population growth is shifting to the Global South, with the future of urbanization unclear post-Covid. On top of these trends, we are on the verge of creating artificial forms of intelligence without understanding their true effects on us.
Long-term institutions can choose among four distinct approaches to creating investment value in public markets within the context of disruptive trends like these.
The original approach is being silent, or taking no position. Silence remains tenable only when individual trends are immaterial to an institution’s returns and responsibilities; it can’t work as a general approach for long-term institutions. Institutions historically have taken a principled approach instead, applying their values to allocating their money based on rules or, more recently, by using an analytic approach of incorporating future scenarios into decision-making. Both approaches have their place, but neither has brought asset owners and companies closer.
The remaining approach is catalytic, with investors and companies actively trying to change markets, economies, or even societies through their capital allocation choices. The “constructive capital” rubric used by Caisse de dépôt et placement du Québec, which finances Quebec’s pension fund, is one example. Meanwhile, the New Zealand Super Fund explicitly uses “sustainability” to describe this approach.
Investors and CEOs using their power to change the world around them provides the best hope for restoring value-creating potential to relationships between public companies and asset owners. But it may not be good enough. Investors and companies that seek to remain in public markets and derive value from their relationships will need ways to find each other in the masses of intermediaries between them, special tools for using this approach, and plans for navigating the inevitable collisions with short-term activists.
Going to private markets raises its own questions: How can long-term investors and companies continue to fulfill their responsibilities to savers and communities if private markets — which are more opaque and less familiar — are where these investments need to happen?
This will be among the most strategic choices for a generation of executives: reimagine how they create value together in public markets or continue shifting heavily into private markets and figure out how to fulfill their responsibilities in that context. Either way, long-term institutions are responsible for the same outcome: investing in businesses and creating value together.
Matthew Leatherman is a research strategist at FCLTGlobal, whose mission is to focus capital on the long term to support a sustainable and prosperous economy.
