Had anyone told me that McKinsey and the Canada Pension Plan Investment Board (CPPIB) would challenge the institutional investment system as I’ve been doing, I’d have laughed. But when tipping points are reached, paradigm change can happen fast. Coming hard on the heels of the Kay review and the UK fiduciary duty review, two insiders have acknowledged that institutional investor behaviour is harming business performance and society.
They are McKinsey, the finance sector’s favourite consultancy, and the CPPIB, a poster child for a well-governed mega global pension fund. Their recent report really is a must read but here’s a preview.
“Calls in the past five years for corporate leaders to abandon their focus on maximising short-term financial performance have been ineffective.” Despite all the talk “the situation may actually be getting worse”. And they point the finger clearly: “The main source of the problem… is the continuing pressure on public companies from financial markets to maximise short-term results.”
Institutional investors “should have both the scale and the time horizon to focus capital on the long term” but they conclude that this isn’t what happens today: “To put it bluntly, [investors] are not acting as owners.”
Furthermore: “…short-termism is undermining the ability of companies to invest and grow, and those missed investments, in turn have far-reaching consequences, including slower GDP growth, higher unemployment, and lower return on investment for savers.”
Their programme for change has four legs: invest the portfolio after defining long-term objectives and risk appetite; unlock value through strategic engagement and active ownership with investee companies; demand long-term performance metrics from companies to change the investor-management conversation; and structure institutional governance to support a long-term approach.
Some might say this agenda is rather obvious. But even these modest reforms will be hard to implement given the sector’s profound immunity to governance-led changes. Others might say the authors ignore externalisation of costs to the environment and future generations. McKinsey has deep expertise on the eco-resources crunch so it’s disappointing they didn’t join these dots, even if it’s hard for some to utter the words “man-made climate change” and accept the imperative for low carbon development.
Others might highlight the lack of detail on what’s possible now, specifically:
• To improve significantly how the proxy advisory system works vis-à-vis corporate pay, a major driver of short-termism. Upgrading this part of the investment supply chain, so recommendations are better informed and further challenge of CEOs and their remuneration consultancies, McKinsey included, is critical.
• While the search for better performance measurement is critically important, there’s no reason to delay action on what is known. McKinsey is a well-known advocate for some basic key economic performance indicators as drivers of real business-model value creation for shareholders.
And yet others might challenge them for insufficient thinking about pension investing directly into real economy and wealth creation, a topic to which I will return.
To hold two opposing ideas and retain the ability to function is apparently a sign of first-rate intelligence and I, for one, agree with both reform and revolution. Indeed, it would be particularly revolutionary if McKinsey reformed its own corporate culture – culture change being a core McKinsey competency – so their frontline consultants pushed these ideas. That would, indeed, take away my job.
Raj Thamotheram is an independent strategic adviser and CEO of Preventable Surprises and visiting fellow at the Smith School of Enterprise and the Environment, Oxford University