Asset owners – the cornerstones of the investment ecosystem – often have very long-term investment goals, such as building endowments for perpetuity and providing for the next generation. One of their challenges lies in in the fact that their assets are invested by external managers who may have vastly different time horizons and incentives in mind. How can investors preserve a long-term focus and avoid short-term behaviors when designing investment mandates?
This was the topic of conversation recently in Toronto, where FCLTGlobal CEO Sarah Williamson joined Top1000fund.org’s Fiduciary Investors Symposium, or a panel on how investors are taking the long-term view.
Mario Therrien, Caisse de dépôt et placement du Québec (CDPQ), raised the central question. “We try to outline the investment policies, risk appetite, benchmark, post investments and everything [in our mandate], but how do we execute on it? How do we make it live?”
In a separate session, MFS’s Carol Geremia remarked similarly that “I’ve been in the business 40 years, and I’ve always learned that’s not how you take on risk [with more and more instantaneous metrics] – you extend your time horizons, you don’t shorten them. Yet, we’ve built this measurement system, because it’s so hard to figure out the markers to the longer-term destination.”
This viewpoint has gradually taken hold across the industry. Ontario Teachers’ Pension Plan has written publicly about its approach to navigating this challenge, as has Kempen. And each of these organizations, in collaboration with dozens of investors have worked with FCLTGlobal since 2017 to create and advance long-term provisions for investment relationships, including mandate agreements.
Those mandate provisions include exactly the ones referred to in Toronto. Indeed, MFS made a simple but impactful change of reversing how it presents performance numbers so that longest-term data comes first and shortest-term data comes last. And State Street offers important research about how to extend time horizon through the ways that an investor takes on risk, especially – as these long-term mandate provisions emphasize – by evaluating risk and return over multiple time horizons. OTPP has affirmed this view as well, commenting in an earlier FCLTGlobal publication that it’s “Partners understand the balance we must achieve between appropriately managing our risk of loss and being able to take enough risk to earn our overall expected return.”
Of course, commitments like these begin with due diligence. Finding the right match for the long term establishes alignment early in the process and ensures there is an “opportunity fit” between the asset owner and manager on philosophy, investment beliefs, and long-term value creation. This reduces the element of surprise in negotiating specific mandate provisions.
Long-term key performance indicators for those interactions may include asset-weighting a manager’s corporate engagements and differentiating engagements based on how they happen (e.g., letter, call, in-person meeting, site visit) and the decision-making authority of both the manager’s and the corporation’s representatives.
More broadly speaking, engagement is what these long-term investment relationships are all about. The ways that an owner engages a manager and that a manager in turn engages a company determine whether long-term focus is preserved or eroded. Each agent in the value chain – owner, manager, and corporation – ultimately is accountable for fulfilling the long-term goals of savers who have entrusted their money to them and of communities that rely on them for value-creating goods and services.
Asset owners and asset managers are counterparties to investment contracts – effective investment mandate design ensures accountability in this value chain. This can easily evoke the image of lawyers sitting across negotiating tables and balancing competing interests. That is sometimes the case, but not always. Owners and managers can share a focus on the long term, have tools for realizing that focus, and are both ultimately better off when they are able to realize this long-term potential together.
Incentive Alignment | Toolkit
19 July 2022 - This matrix provides a menu of key contract provisions for mandates. We compare typical provisions, which tend to reflect a short-term mindset, to those promoting a longer-term approach, and offer ideas for exploratory provisions. The provisions are relevant for separately managed accounts and commingled funds, with unique provisions described for the latter.
Incentive Alignment | Report
19 July 2022 - FCLTGlobal has conducted research since 2015 to facilitate the creation of mandates that align asset owners and asset managers long-term goals.
In the News
27 July 2022 - FCLTGlobal’s latest report provides a starting point for mandate negotiations that emphasise long-term provisions, rather than short-term incentives which it said are common in today’s investment contracts.