Why the world’s largest asset managers are pushing long-term thinking
Recently, the CEOs of the largest global asset management firms put portfolio company executives on notice that their current short-term focus can be a barrier to long-term growth.
Larry Fink, CEO of BlackRock, led the charge with his 2016 corporate governance letter to CEOs, saying, “Today’s culture of quarterly earnings hysteria is totally contrary to the long-term approach we need. … We are asking every CEO to lay out for shareholders each year a strategic framework for long-term value creation.”
Just 25 days later, Fink’s sentiments were echoed in a letter from Ronald O’Hanley, president and CEO of State Street Global Advisors, who warned of “the perils of companies focusing on short-term results at the expense of long-term value creation.”
A few days after that, Vanguard Chairman and CEO William McNabb explained how “good governance is a key to helping companies maximize their returns to shareholders” over the long-term and reminded companies how “in the past, some [companies] have mistakenly assumed that our predominant passive management style suggests a passive attitude with respect to corporate governance. Nothing could be further from the truth.”
This isn’t just a philosophical discourse, the “Big 3” asset managers — Vanguard, BlackRock, and State Street — with combined assets under management of more than $11 trillion, mean business. They are encouraging publicly traded companies to adopt and regularly disclose long-term strategic plans and governance practices.
It is not just the Big 3 making this case. Other asset owners, financial institutions and CEOs are taking a similar stance. Clara Miller, CEO Emeritus of The Heron Foundation, observes that well-managed and ethical enterprises of any size or tax status that combine mission and money in their regular operations create long-term value, while poorly managed organizations that separate mission and money routinely extract short-term value.
This alignment and congruence among leading investment managers, and their leaders’ public communications in support of long-termism, is thought by many to be unprecedented. How should forward-looking CEOs and boards respond?
Long-termism and ESG integration
As the director of CECP’s Strategic Investor Initiative, an effort to shift trillions in investor assets to companies that adopt and communicate long-term strategies that integrate financially material environmental, social and governance (ESG) factors, the question I’m asked often is, “What’s the connection between long-termism and ESG adoption and integration?”
Despite a shifting regulatory environment, the demand for companies to think long term and incorporate ESG factors into their business model is growing. Academic research shows that CEOs who incorporate sustainability into strategy and have the discipline to also manage short-term financial expectations create more shareholder value. While achieving the right ESG balance requires an investment of time and money, this shift in corporate strategy promises to deliver sustainable value and reduce risk in the long run.
Investors are now asking for three- to five-year goals and are encouraging CEOs to align their corporate objectives with those of their key constituencies. Managing to long-term goals that take a holistic view of the business creates the context for the short-term communication about quarterly earnings. That’s why increasingly, America’s largest institutional investors are asking companies to provide long-term plans that integrate financially material ESG factors.
Professor Clayton Christenson of Harvard Business School illustrates this point, looking back at the telecommunications industry as it existed some 15 years ago. At that time, Lucent and Nortel were the darlings of that industry, while Cisco was a relative unknown. Over the next 10 years, Cisco would ultimately overtake Lucent and Nortel and emerge as the clear industry leader. How did this happen?
Dr. Christensen opined that Lucent was vulnerable because it focused too much on maximizing short-term quarterly profitability and did not invest enough in long-term R&D. "Tomorrow's investments that pay off tomorrow go right to the bottom line and are much more tangible than investments that pay off 10 years from now," he said. "The reason some successful companies fail is they are drawn to investing in things that provide the most immediate and tangible evidence of achievement ... often with sad long-term results."
Companies that fail to balance short-term expectations with long-term results often overlook the importance of identifying and developing strategies to address material risks and opportunities in ESG-related aspects of their operations and governance structure. For example, unchecked global climate change represents material environmental financial risks to many companies and opportunities for others, but these long-term risks are mostly absent from quarterly earnings calls and annual disclosures.
Societal shifts, changing cultural norms and planetary boundaries create, for each company, its own unique set of material risks and opportunities. These are often invisible to short-term investors and traditionally viewed as non-material on a quarter-to-quarter basis.
Leaders of the Big 3 global asset managers have begun to make the case that the long-term return horizon of their largely indexed portfolios needs congruent strategy disclosure from their portfolio companies begin communicating strategies that look three, five and even 10 years ahead. They also point out that long-term performance plans create the context for “building blocks” for short-term financial success and are not a substitute for transparency.
A new ecosystem of initiatives
A new opportunity exists today for business and investors to collaborate and build on this vision of long-term leadership. Companies now have an opportunity to shape this next generation of long-term plans. Four key initiatives are gaining momentum, and each is ramping up stakeholder participation. These include:
- The Sustainability Accounting Standards Board (SASB) develops sector-based accounting metrics suitable for disclosure in standard filings such as the Form 10-K and 20-F. Through its evidence-based approach, SASB can dramatically accelerate how companies improve the precision, and disclosure of material sustainability indicators.
- Focusing Capital on the Long-Term (FCLTGlobal). FCLTGlobal is an initiative for advancing practical actions to focus business and markets on the long term. FCLTGlobal’s mission is to develop practical structures, metrics and approaches for longer-term behaviors in the investment and business worlds. In addition to hands-on research, FCLTGlobal’s founders and members will advocate for the adoption of these structures and metrics within the investment community and in corporate boardrooms.
- The Task Force on Climate-Related Disclosures (TCFD) develops voluntary, consistent, climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers and other stakeholders. TCFD considers the physical, liability, and transition risks associated with climate change and what constitutes effective financial disclosures across industries. The work and recommendations of TCFD will help firms understand what financial markets want from disclosure to measure and respond to climate change risks while encouraging firms to align disclosures with investors’ needs.
- Global Reporting Initiative (GRI) is an independent organization that helps businesses, governments and other organizations understand and communicate the impact of business on critical sustainability issues such as climate change, human rights and corruption.
Collectively these four initiatives, each with a distinct but linked role in the emerging long-termism landscape, will:
- Transform corporate disclosures for material information and value-generating strategies;
- Reposition corporate reporting to tell a more complete story of how an organization’s strategy, governance, performance and products lead to the creation of multi-stakeholder value and enterprise viability over the long term;
- Improve the disclosure precision of sector-based ESG performance indicators and accounting metrics;
- Accelerate the integration of long-term value factors into investment and credit rating decision making.
CECP, “The CEO Force For Good," was founded by actor, entrepreneur and philanthropist Paul Newman and John Whitehead, former chairman of Goldman Sachs. They believed corporations and their leaders can and should be a force for good in society. CECP’s Strategic Investor Initiative (SII) is a logical extension of this vision, creating forums where CEOs can present long-term plans to long-term investors and demonstrate the greater sustained earnings power proven to come from longer-term thinking.
In September, CECP will convene a group of leading institutional investors, CEOs and other senior leaders from global companies at its second CEO Investor Forum in New York City. Participants will learn about long-term corporate strategies, including plans to address material environmental, social and governance risks and opportunities, from visionary executives who have taken to heart Miller’s notion that creating value over the long term is ultimately the better path to prosperity — for everyone — and that extracting value through focusing solely on short-term results yields to lower returns over the long term. Companies will be rewarded for this new long-term approach, while those who choose the short-term status quo are likely to end up, in Dr. Christensen’s words, delivering “sad results.”