A model framework to help institutional investors to tackle short-term investment pressures by defining mandates in line with their long-term goals has been published by FCLTGlobal.
Based in Boston, Massachusetts, the non-profit organisation – whose members are leading companies and investors worldwide – develops actionable research and tools to drive long-term value creation for savers and communities, in order to support a sustainable and prosperous economy.
”Institutional investment mandates: anchors for long-term performance” is the third, updated report on long-term investment mandates since FCLTGlobal started researching the topic in 2015.
According to the report’s lead authors – Matthew Leatherman, managing director, programs, and Joel Paula, research director, at FCLTGlobal – short-term pressures are hard to avoid, despite the overwhelming evidence of the superiority of long-term investments.
“The relationship between asset owners and managers presents a classic time-horizon mismatch,” they said. “The asset owner has a specific set of investment objectives that correspond to its stakeholders, liabilities, responsibilities, return goals, and risk tolerance. The manager has a different set of stakeholders.”
Investee companies are a further element in non-alignment; Leatherman and Paula said most corporate executives agree that longer time horizons for business decisions would improve performance, yet half believe they would delay value-creating projects if it meant missing quarterly earnings targets.
A 2019 State Street survey of nearly 1,000 investment professionals found that 77% of asset owners voiced concern that short-term incentives were not being aligned with long-term objectives, with 57% of managers agreeing.
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.
“The relationship between asset owners and managers presents a classic time-horizon mismatch”
Practical tools for investors include a due diligence “Top Ten” list of topics, with suggested questions for investors on:
- Fees – Do the fees and fee structures reward a long-term focus? Fees that decline with the longevity of the partnership, rather than assets under management, may provide asset owners with incentives to be more patient through periods of underperformance.
- Reporting – Does this highlight long-term investment risks and future investment prospects? Reports could discuss long-term returns first and primarily comment on annual or longer performance.
- Benchmark – To what extent does benchmark-relative return capture a specific strategy’s performance? Are any other metrics as important, such as absolute return or liability matching?
A further section applies these questions to reorienting a portfolio for meeting a net zero 2050 climate commitment.
Provisions within the long-term mandate contract itself are covered with discussion and advice on issues such as the contract term, fees, the manager’s capacity for assets under management, the manager evaluation process and engagement with investee companies.
In addition, the report includes:
- An example statement on return objectives, risk tolerances, and accepted investor responsibilities that could affect how returns are expected to be earned;
- A blueprint for setting key performance indicators;
- An asset manager scorecard to provide a consistent method of evaluating a manager’s performance on an ongoing basis;
- Case studies of FCLTGlobal members applying the research to their own mandates, including the Ontario Teachers’ Pension Plan, New Zealand Supannuation Fund, and asset managers Kempen Capital Management and MFS Investment Management.
“Well-designed mandates explicitly integrate provisions that reflect long-term objectives,” the lead authors observed.
“By conducting effective due diligence and incorporating long-term objectives into the initial contract, asset owners and managers can help ensure fruitful investment partnerships that both satisfy their needs and support the productive long-term allocation of capital across the investment value chain.”