4 KEY MEASURES: How Asset Owners Can shift to the long term
Dutch pension funds should rediscover the purpose of their investments. I believe pension funds have concentrated heavily on short term stimulus over recent years, such as coverage ratios and providing savers with above-inflation nominal returns. Instead pension funds should be concentrating on using their pension assets to stimulate more sustainable economic growth and in making a structural contribution to the creation of economic value over the long term
As Senior Manager of KPMG Sustainability, Lars Kurznack leads the firm’s sustainable finance and investment team. His clients include global, regional and national banks, insurance companies, asset managers, real estate companies, private equity firms.
SHIFTTO welcomed Lars as a new Board Member in March 2017. After the publication of the press release below in April 2017 regarding the status of the Dutch pension fund in the shift to long term investing, Lars sat with SHIFTTO editors to present the four key measures asset owners can implement to shift to the long term.
First, the press release:
KPMG: "Pension funds must focus on long-term value creation"
Dutch pension funds should be concentrating on using their pension assets to stimulate more economic growth and making a structural contribution to the creation of economic value over the long term. That means the funds shouldn’t look solely at short term financial returns, but also at the long term consequences their investments will have on the economy, environment, people and society, according to Lars Kurznack, Senior Manager KPMG Sustainability. "Due to short-term thinking in the investment management industry, non-financial factors and long-term value creation are not always given the same weight as financial factors and short-term performance,” he says. "A real breakthrough for responsible investment within the Dutch pension sector is only possible, therefore, if these considerations are integrated into the core task of pension funds: to maximise the value and stability of pensions. Ultimately both factors are determined by the added value – both short and long term – that will be seen in our economy.”
Innovation needed in responsible investment
Kurznack notes that responsible investing is, more and more, intertwined in the investment strategy and core processes of pension funds and pension providers: "The result is that responsible investing is no longer a matter strictly for sustainability specialists, but for the whole organisation. This requires a different approach to responsible investing. In addition, a number of current developments in the pension fund and pension provider sector means they are being forced to innovate in the field of responsible investing. Firstly, responsible investment is firmly on the agenda of national central banks and international financial regulators. De Nederlandsche Bank (DNB), for example, sees that responsible investing contributes to sustainable prosperity and therefore to the financial stability of the Dutch economy. Secondly, the legislature is increasingly keeping responsible investing in its sights – for example responsible investing is becoming more prevalent in legislation regarding governance and risk management for pension funds.”
Optimising investment performance
Also the pension funds themselves are contributing to this change. Kurznack: “A number of industry leaders have formulated concrete performance targets in the field of responsible investing. The expectation is that medium and smaller pension funds will follow this development. In addition, and in part from societal pressure, pension funds increasingly want to see both the positive and negative societal impacts of their investments. Moreover, it is expected that long term investments with a good cash flow will, under continued pressure of low returns, gain in popularity in the coming years,” he says. “In such long-term investments, sustainability-related factors are increasingly relevant in optimising the investment performance of the assets. That is the most important social role of pension funds, and where the real added value of responsible investing lies: the conversion of pension assets into maximum value creation for the real economy over the long term, as opposed to short-term thinking. Thus the goal of responsible investing becomes contributing to maximalising the value and stability of pensions. Finally, this will also put an end to the struggle between the 'believers' of responsible investing and the rest of the organisation."
Q: Lars, thank you for your time. In your opinion what should Dutch pension funds be focusing on?
Dutch pension funds should rediscover the purpose of their investments again. I believe pension funds have concentrated heavily on short term stimulus over recent years, such as coverage ratios and providing savers with above-inflation nominal returns. Instead pension funds should be concentrating on using their pension assets to stimulate more sustainable economic growth and in making a structural contribution to the creation of economic value over the long term. In the end the future pensions ultimately depend on this earning capacity.
Q: How can pension funds make this shift?
Amongst other means, there are four key measures that help pension funds to shift to long-termism:
- Pension funds should develop an investment strategy that creates sustainable long-term wealth for beneficiaries and the broader real economy
- More consistency and depth in implementation of responsible investment and long term investing policies (e.g. translation of ESG risks and opportunities in financial terms, adoption of long-term stewardship)
- Change in their governance (e.g. performance measurement) and culture
- More meaningful reporting and communication, e.g. reporting about the long term performance of investment portfolios
Q: Can you elaborate on those four measures a bit?
Yes, but first of all I want to make clear that the current way responsible investment is being implemented by many asset owners seems not to create the long-term wealth for beneficiaries and the real economy as described above. If you listen very well to critical participants in the industry, they say that the true paradigm shift to responsible investment has not taken place yet because the investments people are making are based on old economic models that have been in place for 20 to 30 years and that their investment horizon is rather short-term focused. Responsible investment needs a more strategic umbrella, and this umbrella is long term investing.
The four measures are ways that asset managers can implement and accelerate this shift.
Q: Is this clinging to old investment models and attitudes the reason the implementation of responsible investment isn’t going faster?
Yes, it is one of the key barriers. We see organisations trying to implement responsible investment, but since most asset managers have a short term asset horizon, they do not always see material ESG factors impacted by their investments, for example climate risks or risks related to resource scarcity. If you don’t see those factors because of your short term investment horizon, you won’t take them into consideration in your decision making.
A lot of sustainability or societal trends impact us and there is no short term incentive to do anything about it. For example, everyone know climate change will cost the next generations a lot of money but there is not always a clear incentive to do anything about that in the short term. This is very much related to what Mark Carney, the Chair of the FSB and Governor of the Bank of England, called ‘The Tragedy of the Horizon’ when he announced the formation of the Task Force on Climate-related Financial Disclosures (TCFD) in December 2015.
If you want to strategically and structurally incorporate positive and negative societal impacts of investments in investment decisions, you need to shift to the long term. Otherwise the shift to responsible investing won’t happen in the core of your investment processes. Your ‘responsible investment’ will remain, but as a niche – basically an add-on. There is no fundamental change from this.
Q: Are there concrete examples in this regard?
Yes. For example, if you look at the top 15 largest Dutch pension funds, we find 100% of them have a responsible investment policy. But if you ask how they have incorporated long termism into their investment principles, then less than 50% have operationalised the long termism in their principles.
Another example: If you think of the quarterly earnings investor calls of listed companies, most questions these companies receive from participating investors are focused on short term financial performance. These investors have mainly a short term investment horizon. They won’t ask questions about ESG-related performance of their investee company, because ESG-factors mainly impact the longer term performance of the company. It doesn’t influence their decisions fundamentally.
When you shift to the long term view you put different filters and lenses on investment decisions. With those lenses you can identify such societal risks or opportunities of investee companies.
Q: So that illustrates the third measure above – operationalising long termism by shifting culture and governance in firms.
Yes, you need to adjust your governance and organisational culture in such a way that it supports and stimulates investment analysts and managers to apply a long term lens to their investment decisions
Q: In the press release above, you mention that non-financial issues aren’t taken as seriously as financial issues in the current investment climate. So let’s talk about the last of the 4 measures above. Are you advocating for a change in business reporting as part of long-termism?
It’s a very relevant question, because basically we are in a chicken and egg situation. A lot of institutional investors are willing to incorporate the long horizon and ESG factors, but there is often a lack of good data about corporate performance and value creation on the longer term.. And if this data is there, it has often little direct connection to financial value of a company.
At KPMG we looked at the content of 270 larger listed companies’ annual reports and saw how they report on performance, and most companies report on past financial performance first. It’s backward-looking information. Not a lot of companies report on the longer term business success, in the form of metrics that say something about the long term viability of financial performance. And to go back to the investors, they are right in saying that hey, the company doesn’t report about that so we can’t include it. And from the other perspective, companies say – hey, investors don’t ask about long term performance, so why should we proactively report about it?
Q: How can the investor help?
Adaptation of long term stewardship by companies is key. Instead of considering their investments in companies as a “financial transaction”, they should become a stewardship provider that looks to the long term and sustainable wealth created by its investments. .
Long term investors, such as pension funds, should more proactively enter into dialogue with companies and explain which type of longer term performance metrics, information and data that says something about the long term viability of a company’s financial earnings and business model. For example, information about customer value created, human capital or negative societal impacts created by certain business activities of the company. This information helps investors make better and more holistic investment decisions. Often companies lack a clear idea about what investors expect from them.