Monday, November 14th, 2016
“Leadership is, among other things, the ability to inflict pain and get away with it — short-term pain for long-term gain.” George Will
Since the 2008 financial crisis, a growing refrain has urged the US and other economies to move away from their focus on quarterly results and toward a true long-term mindset. A host of solutions have been offered — from “shared value” to “sustainable capitalism” — that spell out in detail the societal benefits of such a shift in the way corporate executives lead and invest. Yet despite this proliferation of thoughtful frameworks and the evidence that returns are better with a longer term mindset, the shadow of short-termism has continued to advance and frighteningly, the situation may actually be getting worse.
Endowments are giving up their single biggest advantage, time. Many endowments and foundations have the ultimate advantage of holding a perpetual pool of capital. These institutions are the supreme long-term investor, with no assets it cannot hold. Shorter term investors, those with shorter dated liabilities, are innately denied this luxury.
Not only are endowments failing to engage with managers and corporate leaders to shape the long-range mindset, many are failing to engage in environmental, social, and corporate governance discussions to align investment with the broader objectives of their missions and fiduciary duties. They are using short-term investment strategies designed to track closely with benchmark indexes like the S&P 500 or the MSCI All Country World Index. They are letting their investment consultants pick external asset managers who focus mostly on short-term returns. To put it bluntly, they are more like renters than like owners. At Verger Capital, we have no intention in tying the future of our clients to the S&P or the MSCI.
Endowments need to ensure that both their internal investment professionals and their external fund managers are committed to this long-term investment horizon. Common compensation structures like a 2% management fee per year and a 20% performance fee do little to reward fund managers for long-term investing skill. Paying a CIO to beat a peer group or giving a bonus to the endowment staff for being in the top quartile of NACUBO in a given one-year period doesn’t reinforce a long-term perspective. Regrettably, ignoring the risks taken and fees paid to achieve those returns is more often the norm at endowment investment committee meetings.
Still, many endowments will tell you they have a long-term perspective. Yet rarely does this philosophy permeate through to individual investment decisions. For this dynamic to evolve, investment committees and CIOs should start by defining exactly what they mean by long-term investing and what practical consequences they intend. This definition must include a multiyear time horizon for value creation and compulsory instruction to committee members to look and think beyond their terms as a trustee.
Just as important as the time horizon is the appetite for risk. How much downside potential can the asset owner tolerate over the entire time horizon? Risk matters, and negative compounding can have a severe impact when you are dipping into an endowment corpus for a 5% annual spend. A school that uses its endowment primarily for financial aid has a much different risk appetite than a school that uses it for “a lazy river and free-range chicken in the dining halls”, as Malcolm Gladwell alluded.