While contracts between institutional investors and asset managers can inadvertently encourage short-term investment decisions, a new report by FCLT Global is recommending nine key areas where both parties can align their interests.
The not-for-profit organization’s stated goal is to encourage investors, such as pension plans, to look at allocations through a longer-term lens. It brought together working groups of global institutional investors and asset managers to discuss what strategies are working, and ways to tailor investment mandates to bolster long-term success.
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One difficulty in maintaining a long-term perspective across the board is that asset managers’ investment practices may not necessarily align with the long-term outlook of an investor, according to the report, which notes that bringing the asset owner and manager together to work towards the goal of long-term prosperity is key.
The report also identifies the main areas where both parties should be on the same page:
1. Fees: Does the fee structure with an asset manager reward longevity? This could strengthen the relationship with the investor and increase the manager’s flexibility to use longer-term strategies.
2. Benchmark: How should the investor measure success? Ensure benchmarks are relevant and provide further metrics to paint a clear picture of progress.
3. Term: Contracts should also encourage longevity. Rather than an at-will contract, an agreement extending a few years could establish firmer long-term expectations, but would still provide an opt-out opportunity.
4. Redemption: With longer-term strategies, liquidity limitations are a common issue. Allowing in-kind redemptions could be one way of stretching these limits.
5. Capacity: Investment strategies with capacity limits can encourage discipline in maintaining a strategy. When a strategy shows growth it can be tempting to add to it, but the capacity limit reigns the investor in from making allocations that would exceed the strategies long-term outperformance potential.
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6. Performance report: Reporting should focus primarily on longer periods, such as by-year or longer to ensure short-term issues don’t cloud long-term priorities.
7. Disclosures: Changes to personnel or administrative processes could be important to future performance and managers should disclose them.
8. Active ownership: Management policies in interacting with companies are something investors should know about in order to determine whether these activities support a long-term strategy, such as using proxy votes.
9. Evaluation: A problematic period should not be the only time an investor evaluates a manager’s performance. Regular checks can improve communication between the asset manager and the investor.
“Investment mandates have the power to be the anchor that aligns behaviour and objectives, focusing asset managers on long-term value creation,” said Mark Machin, president and chief executive officer of the Canada Pension Plan Investment Board, which is one of the founders of FCLT Global. “At the outset of any new mandate, asset owners must deliberately work with their asset managers to clearly articulate the terms of investment contracts, making sure to align goals, incentives and key long-term performance indicators.”
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