[This is an extract of an interview with MFS Investment Management President and Head of Global Distribution, Carol Geremia. Recently, Ms Geremia visited Australia and spoke at the CFA Society investment conference in Melbourne.]
James Gruber: You speak of a growing disconnect between the purpose of the investment industry and real-world outcomes. Can you first define what you believe the purpose of the industry is?
Carol Geremia: Yes, and I'll just preface this by saying part of my comments in my paper is referencing the Big Shift - that's the paper that State Street wrote - and I thought they did a good job defining the purpose of the industry is. It's really to support or drive economic prosperity by allocating capital responsibly and helping investors achieve long-term financial goals. It's really this dual purpose that I think is an important distinction, not one purpose about helping investors meet financial goals. Much of it is how also we're putting their money to work.
Gruber: You talk about a disconnect between the purpose and what investors need. Can you elaborate on that?
Geremia: Yes, this growing disconnect of, we have become so short-term and one of the stats that I use is the average holding of a stock in 1950 was eight years and today it's five months. And I think that as investors, and as risk has increased dramatically, we've continued to just pile in lots and lots of money into risk areas like equities and ownership of equities, and it's having probably an unintentional effect to creating the misalignment. We say we're long-term, we say we want to allocate capital responsibly, and yet as time horizons have shortened, we've really sent different messages and incentives to the companies that we own inside the portfolio. It also incents the adviser to try and hold us accountable as active managers, which is a good thing to do, but it's in shorter periods of time. So a full market cycle has almost gotten cut in half.
Nobody gives you a full market cycle really to perform and the residual effect of that is that people are hiring and firing active managers based on past performance. It’s this chasing past performance environment, and again I think is a misalignment to how we should be putting other people's money to work.
Gruber: If I put that simply, investors are thinking shorter term, therefore institutions are investing shorter term and that's increasing risks for both. Is that a fair summation?
Geremia: No, I think it's just missing one last piece … that short-term drive to meet performance pressures is also impacting the companies that we're investing in because they really see that their shareholders, their owners, are short term in committing capital to their strategy, to their underlining business … it's like a cascading effect.
Gruber: That's a good way to explain it.
Geremia: It's a cascading effect, but you did start with the right comment which is at the end of the day it does increase risks as we shorten time horizons and shorten them more and more. It's increasing the risk that you're not going to generate the long-term results that you're saying that you're going to generate.
Gruber: The other side of it, which you mentioned in your presentation, is that we've had this plethora of products that have been created over the recent decades, and most prominently, probably passive funds, you've also had private equity, venture capital, all these kind of things. The providers of these products would say they de-risk portfolios, but you seem to indicate otherwise. Would that be correct?
Geremia: Yes, I'm not even sure how they say they de-risk. I don't even know what that argument is, quite frankly, because I think there's 2.4 million indices to 43,000 companies. I'm not saying those are products, they are benchmarks. But the whole idea is that we're building portfolios to measure ourselves against all these benchmarks. And so it's created this short-term pressure to beat the benchmark when, the benchmark is a passive owner of companies they haven't looked at, haven't studied, don't know management. You don't know what you own, you're just part of the benchmark. All of that increases risk in terms of not knowing what you own.
Gruber: Sure. And the other aspect which you touched on earlier, the whole concept of shareholder value, which has been trumpeted for a long time, you're advocating something different for the industry. Why is that?
Geremia: Well, it's less an advocation, it's questioning. It's questioning whether shareholder primacy still works. And I cite Leo Strine in suggesting that it hasn't worked. I'm not saying it hasn't worked completely. I think that the point is that the pressure companies are under today are having to respond to the stakeholder versus just the shareholder. They've got to prove that they are treating their employees well today. They've got to ensure that they've got a climate transition plan. They've got to provide massive amounts of measurement data that they're on target to meet net zero. All of these things actually are going to impact returns. That in the short term, this idea of maximizing profits for just the shareholder is under a great deal of pressure because of all of these systemic risks that companies are having to answer for. My question to Leo Strine is that shareholder primacy might have been a 'win win that hasn't' but could Milton Friedman (who developed the shareholder primacy theory) ever have imagined so much passive capital in the system? If our measurement stick, our measurement benchmarks did not become investable assets or an investable portfolio, could shareholder primacy have worked?
Gruber: What do you see as some of the solutions for the investment industry to address some of these problems?
Geremia: I think there's just a lot of good opportunity to change the dialogue in what we want to hold managers accountable to do. It's one thing if it's just, hey, I have to generate the highest return for your retirement account. That's what an investor might want. But then if you tell them, well, I'm trying to make sure I'm not investing in companies that are dumping sludge in the river using third party supply chains that have human trafficking. All of these things that have become reality to our economies and the global markets, we've got to bring this story of responsible allocation and stewardship to light. And like I said, I think technology could be our friend here, but it's to demonstrate other measurement factors that show value for money. But as an industry, we should step into that as an opportunity to show a stakeholder view versus just beating a benchmark in one, three and five year periods of time.
This is an extract of an interview with MFS Investment Management President and Head of Global Distribution, Carol Geremia. Recently, Ms Geremia visited Australia and spoke at the CFA Society investment conference in Melbourne.
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