Mirova Insight 3
For some, a responsible investment is by definition a long-term investment. And they’re right, to be sure. Problems arise, however, with any attempt to define these terms. Surprisingly, it is almost as difficult to achieve a consensus on the meaning of long-term investment as it is to arrive at a broadly acceptable definition of responsible investment.
We will not here revisit the question of how responsible investment is to be defined, having treated it extensively elsewhere, but rather use our own understanding of the term: an investment that seeks to deliver a threefold return that is social, environmental and economic, thereby reconciling the pursuit of individual profit according to a particular management approach and the long term general interest. But, given how politicians, anxious about the difficulties of securing long term financing are nonetheless enacting regulations which, in the name of protecting household savers, actually penalize them, and as several working groups, notably within the PRI and UNEP-FI, are venturing definitions and measures to promote long-term investment, we consider it timely and worthwhile to fend off a certain number of preconceptions.
Long-term investment is not long-term
In reality, an investment horizon rarely extends beyond a few years. Even investors holding long-term liabilities confine the management of their equities to horizons that rarely exceed four years; in fact, they unfailingly peruse annual performances, revising their strategic allocations and their tactical positions accordingly. What we call long term in terms of investment is thus fairly short, all things considered. And if, as we believe, investment also means thinking about potential impact on the environment (climate change, resource depletion…) it would be foolhardy to base the definition of long-term investment exclusively on holding period, without integrating the broader environmental picture.
A long-term investment is patient … but not lazy or dormant capital
Often, the only factor offered for identifying long-term investment is how long an asset is held. And yes, this is obviously a significant and necessary piece of information. It would be terribly ironic if high frequency traders were in a position to consider themselves long-term investors. However, it seems to us equally absurd that an investor who closely follows traditional market indices should be able to do so. Such investors might be able to show that their holding period for assets is relatively long, but at no point will their investment decisions be based on long-term concerns. Such investments are conformist in every way. Not only are their initial purchases guided by the number of shares available on the market at a given moment, with no attempt at qualitative judgement or projection, but any (minor) tactical adjustments throughout their investment period can only be dictated by short-term expectations. An investor might thus hold, on average, 10,000 shares of the largest large-cap for ten years, while nonetheless buying and selling hundreds of shares many times over within this period. Choosing to invest in the stock because it is the biggest company, and adjusting margins on the basis of immediate expectations doubly excludes such investors from being considered long-term investors, as far as we are concerned. A long-term investor is above all one whose investment choices are founded on longterm expectations, someone who contributes capital because they believe in a company’s business model and its capacity to innovate. This perspective should automatically result in such an investor holding certain assets for a number of years. Exactly how many is really not the issue. It is perfectly normal for investors to revise their investment decisions at such time as their expectations are dashed, disappointed, or fully met.
Long-term investors must be active investors. They need to be seeking timely innovations, as we do within the pages of this journal by devoting a study to the emergence of civilian drones. They cannot blindly rely on traditional market indices, but must rather establish an approach and investment criteria, as we have attempted to do through the Mirova SI Europe index, which is also described in this issue of Insights.
For these reasons, we have severe reservations regarding proposals for distributing loyalty shares to investors considered ‘long-term’ shareholders on the criterion of holding period alone. By increasing the attractiveness of passive investment, this mechanism could have deleterious effects that erode, rather than contribute to its stated goal of developing long-term investment. What are we proposing instead? In the first place, we should stop subsidizing short-term investment by ceasing to make voters bear the entirety of voting costs. Surprising as it is when you stop to think about it, the costs associated with voting are in fact borne exclusively by those who actually vote. Other measures that would favour long term investing could also be considered, such as offering long-term investors a relative discount should new shares be issued.
A long-term investor is an investor who is active…and engaged
The reasoning described above naturally leads us to this conclusion. Being a long-term investor entails an affectio societatis expressed in an engagement policy that allows investors to play their rightful role in the governance of a company. Of course, this assumes that the engagement policy in questions is not the extension of an unbridled attempt to extort short-term shareholder returns, but rather the healthy exercise of a right, one inseparable from a responsibility to serve the best interests of the company itself. The debate pitting shareholder governance against stakeholder governance, which becomes irrelevant if each party takes the well being of the company as their point of departure, is too often carried over to engagement policies. This is a topic we consider at length in the pages ahead, through an overview of current engagement practices.