Forget the fiddling of the books at BT, the brown envelopes at Rolls-Royce, the shabby governance at Sports Direct. Let’s look into the future to a utopian era in which capitalism works for everyone.
Company chiefs invest and manage for the long term, not distracted by short-term targets and badly structured bonuses, immune to dishonest short cuts. Fund managers back them loyally, impervious to quarterly performance tables.
And agents act in the long-term interest of the ultimate owners: pension fund members and other savers. Capital is allocated more efficiently, productivity improves, investment returns rise, pensions go up and trust in business returns.
Tomorrow’s Company, a think tank, has had a stab at how we might get a little closer to this nirvana in a report for MPs and peers and has come up with a solution which owes rather a lot to the past, in particular those warhorses of the 19th century, investment trusts.
Gigantic, patient pools of capital are the central idea in its proposals to stamp out short-termism. It envisages the creation of say, ten huge investment trusts, each with assets of about £15 billion.
Together they would control 7 per cent of the UK share market, enough to give them huge influence in the boardroom. This would be enhanced by new rules allowing them (and any other shareholder) to designate their shareholdings as “stewardship stakes”. In return for promises not to sell the shares for at least two years, stewardship stakes would qualify for tax breaks and extra voting power in areas such as executive pay.
In order to qualify as a supertrust, the funds would have to meet rules set by the Financial Conduct Authority, which would ration licences to ensure a small number of very big, very powerful players. The chosen few would qualify for additional tax breaks.
Pressure would then be put on pension funds and small investors to funnel money their way. Traditional pension funds could be required to allocate some their assets to the new beasts. Equity Isas could be restricted to investing in them alone.
The supertrusts would help to foster a new philosophy in the companies that they back. Managers would be encouraged to push ahead with new ventures and capital spending plans. Signs of short-termism, such as cost-cutting and share buybacks, would be frowned on.
Projects with high upfront costs would no longer be dismissed in favour of inferior wheezes with shorter payback periods. Currently the average hurdle rate of return for a board to approve capex plans is 18 per cent. That’s insanely risk-averse in a world in which capital can be raised for a fifth as much.
It’s not difficult to pick holes in the proposals. Telling pension funds where to invest borders on illegal. Forcing Isa-holders into choosing these trusts would be politically explosive. The favouritism bestowed on these supertrusts would elicit fury from the rest of the City. A regime policed by the FCA might not exactly inspire public confidence.
There’s a much bigger problem that goes to the heart of the short-termism debate: while few doubt that today’s system is inefficient, there’s no guarantee that a different approach would boost long-run returns.
It might just lead to misdirected capital, extravagance and value destruction. Would these supertrusts, had they existed, have been resistant to the lure of telecoms and dotcom investments in the late 1990s or mining and energy in the early 2010s?
The reason that companies, investment consultants and pension trustees focus so much on the latest quarterly performance numbers is because they are the only thing to cling to in a sea of uncertainty. They might not tell you much, but they are seen as better than nothing.
Professor John Kay’s analysis of short-termism in 2012 was persuasive, but it’s notable that among the companies he lauded at the time, Rolls-Royce and Tesco have turned out to have feet of clay. Long-termism isn’t necessarily easy to identify.
How will the directors of these new supertrusts respond when they underperform in the short run, as presumably they will. They will by definition be shunning the share market fads and fashions that temporarily boost returns.
Even if they are proved right in the long run, the supertrusts face years of self doubt and adverse publicity. And how they will raise the equity they need to grow into the £15 billion beasts envisaged if their own shares trade at a discount to net assets, which sounds their all too likely fate?
It’s all a bit pie in the sky, but the think tank makes some good points. First, investment trusts are much more suited to long-term investment than open-ended funds, at which a damaging investor exodus is always a threat to patience. Second, scale is vital in preventing long-run returns being eaten up by charges. Third, there’s no reason why public policy, tax or regulation, shouldn’t be tweaked to nudge the industry towards longer time horizons.
The proof of the pudding will be in how institutions which are already behaving like long-term investors actually fare. The Scottish Mortgage Investment Trust, which is close to joining the FTSE 100 on present form, is the cheerleader for this approach.
Neil Woodford’s Patient Capital Trust is another important test because of his popular following. It has got off to a poor start, but that’s the curious point. The first couple of years prove nothing. It’s going to be a long haul. Proving long-termism works is by definition a decades-long endeavour.