Royal Institution: Investing As If The Long Term Matters

Investing As If The Long Term Matters

Dr. Raj Thamotheram CEO, Preventable Surprises

Visiting Fellow, Smith School, Oxford University

14 - 10 Club, Royal Institution 15th January 2015

Thanks to Robert Schwarz for research support

SYMPTOMS

Exploding Inequality

Income inequality at levels not seen since the 1930s – and remember what happened after that!

Growing Extremism Happening Again?

http://www.guardian.co.uk/world/2013/apr/01/greece-golden-dawn-global-ambitions (0:00 – 1:05)

Other Costs of Inequality

s

The Great Disruption Has Started

[Climate change risk] “should compel all elected leaders to take immediate action”

Mayor Bloomberg, 2012

s “The hallmarks of tomorrow’s world will be scarcity – of land, oil, food and ‘air-space’ (for greenhouse gases)”

US National Intelligence Council, 2008

The Perfect Storm is Gathering?

The‘Perfect Storm’ (UK Government Chief Scientist, John Beddington, 2009)

s

Loss of Confidence in Mainstream Politics

“How Republicans Went Crazy, Democrats Became Useless, and Middle Class Got Shafted”

“Jean-Claude Juncker Facing Credibility Crisis After Latest Luxembourg Tax Avoidance Scandal”

9

Corporate Governance Failures Galore

PATHOLOGY

Dysfunctional incentives?

CEO  pay  rose  726.7%  from  ‘78  –  ’11  

(2X  S&P  500)    

Mean  worker  pay  rose  

5.7  %  from  ‘79  –  ‘11  

60%-70% of Top 10% are Executives

Irrational Belief in Flawed Theories?

Paul Woolley (formerly GMO Woolley):

“All the data suggests all these theories are valid only in specific and highly artificial situations…

These theories are widely overstated and form a weak theoretical foundation for the whole sector.”

Systemic Disregard for Negative Externalities?

Economies are becoming more dysfunctional

Bubbles – more frequent, more damaging

CFOs will trade off practically everything to protect the quarterly number

Kay Review: investors are driving corporate short-termism

McKinsey & Co and CPPIB: “short-termism is undermining the ability of companies to invest and grow, and those missed investment, in term have far-reaching consequences, including slower GDP growth, higher unemployment, and lower return on investment for savers.”

“Designed by intermediaries for intermediaries”

An Overly Intermediated System

Companies

Pension Funds

Investment Consultants

Investment Managers

Sell-side Analysts

Investment Banks

& Credit Rating

Agencies

Fees Deals

Selection

Returns

Fees

Brokering

Information

Lawyers &

Auditors

Lawyers &

Auditors

Lawyers &

Auditors

Lawyers &

Auditors

Lawyers &

Auditors

Lawyers &

Auditors

Lawyers &

Auditors

Sunday Times, May 6, 2012

“The bulk of incremental financial activity is trading, and trading, while it may provide a little useful public information about market opinion, is largely a way to transfer wealth from those with inferior information and calculation ability to those with more. There is no enhancement of economic efficiency to speak of.” Robert Solow, the Nobel prize winner and an MIT Emeritus Professor

Momentum Investing is Out of Control!

He’s not the problem! HFT & Dark Pools are! Hi

Narrow Conception of risk

Shareholder value

fundamentalism

Weak concern for negative externalities

Regulatory capture

Leadership & Governance

failures Organisational Learning disabilities

Ineffective regulation

Focus on riskier

and dirtier O&G

Outdated approach To safety

Weak safety culture

M&A and Outsourcing/SCM

Saviour CEO

SYSTEM O&G SECTOR BP

The Drivers of “Preventable Surprises”

DIAGNOSIS

Investors = 1° enablers of dysfunction behaviour

“[…] the destruction of shareholder value through legal means is pervasive, perhaps even a routine way of doing business.

Indeed we assert that the amount of value destroyed by companies striving to hit earning targets exceeds the value

lost in these high-profile fraud cases.”

John GRAHAM, Campbell HARVEY & Shiva RAJGOPAL “Value destruction and financial reporting decisions”, Financial Analysts Journal, Vol 62 No 6, 2006

“Investors don’t care about Sustainability” Business Week, 9th Nov 2010

(Global Compact / Accenture survey)

Investors are more important than even regulators in shaping directors’ priorities.

PwC, Annual Director Survey 2010

Most Investors Have No Reason To Care!

Intrinsic investors Deep understanding of strategy/sector More like to support management thru ST volatility 20% of market 4-10 positions

Mechanical investors Mathematical formulae (incl index & closet index) Supporting or not supporting management isn't part of their reality 30% 100-150 positions

22

Traders Bet against market with regards to news Interested in earlier access to better news

35% 20 positions

Adapted from McKinsey & Co

Happy Imbeciles

Market Efficiency Fundamentalists

Denialists

Supportive Pessimists

Sustainability Smooth Talkers

Five (Financial Sector) Patient Types

= Different faces on the same problem!

Thank you for listening!

“Homo Financius”

PROGNOSIS

Ignorance is not bliss!

“If we were told - in any sphere - that we had at least a 90% chance of averting disaster through changes we ourselves could make, wouldn’t we take action?”

Olympia Snow Former Republican U.S. Senator (Maine)

Analysis by Andrew White, Inflection Point Capital Management

Disclosure Alone Has Little Value

http://thomsonreuters.com/corporate/pdf/global-500-greenhouse-gases-performance-trends-2010-2013.pdf

Self Regulation Isn’t Working

Investors: Talking ‘Long’, Walking ‘Short’

²  Only 5 -10% of US $1 Tn/yr needed to de-carbonise has been committed (using IEA figures)

²  Investors have not acknowledged that emissions per unit of world GDP have to fall 6%/yr. through 2100 to stay within 2 degrees

²  Few are actively supporting political efforts to hold warming to 2°C (vested FF interests have much greater influence)

²  A “delay then panic” scenario accompanied by economic, social, and political turmoil remains the most likely outcome

In Private, Investors Agree…

TREATMENT

“The crisis is in implementation”

Kofi Annan (2002)

Why Aren’t We Responding?

Re-discover the purpose of business and finance = to serve society’s needs

COMPANIES: Long-term wealth creation by delighting customers and engaging employees INVESTORS: Fiduciary capitalism and universal ownership Urgency: Current activity (PRI, ICGN etc) is all good. But like treating a patient in septicaemic shock with paracetamol and aspirin. Need equivalent of IV fluids, antibiotics, steroids and emergency surgery.

The Treatment Principles

1. Reduce corporate capture of politics "People with economic power shouldn’t be allowed to buy political power: Friends of capitalism should follow US Senator Rand Paul’s lead and advocate a war on crony capitalism."

Tim Montgomerie, The Times 2. Reduce income inequality 3. Take stewardship actions to get us back on track for 2 degrees max 4. Use disclosure and stakeholder accountability to drive internal change at investors 5. Transform the research supply chain – sell side, credit rating, investment consultants, auditors, legal etc

The Treatment Steps

Be Contrarian/Brave in a Socially Useful Way

“Scientists are understandably protective of the dignity of science and are horrified by publicity and overstatement.”

It’s time for more Positive Mavericks to Just Do it!

Perfection is Not Mandatory!

Thank you & Questions!

http://www.preventablesurprises.com/

Which preventable surprise do YOU really care about?