Pension Trustees Play a Unique Role

November 16, 2016

            Pension fund trustees have immense power and a daunting responsibility to make our markets work, to hold corporations accountable, and thereby to improve our prosperity and the well-being of the next generation.

            There is no doubt that we are fulfilling the Chinese blessing by living in interesting times.  But for the investor in the capital markets, these are times fraught with peril and uncertainty.  For those fiduciaries charged with meeting long-term liabilities with sufficient portfolio returns, the challenges are particularly difficult.  Is anyone else thinking long term anymore?  Asset owners being rewarded on quarterly results? Corporate CEOs whose tenure is often less than five years?  Corporate boards sitting on trillions in cash? Candidates for public office whose careers begin or end in a short while?

            The esteemed McKinsey consulting firm has data showing that between 70-90% of the real value of any corporation tends to be tied to revenues three years out or more.

            And yet companies seem increasingly bent on balance sheet gymnastics in order to goose short-term value, rather than real investment for the long haul.  Valeant Pharmaceuticals, until recently run by a McKinsey person, is a case in point. The company’s board of directors is populated by four or five activist investors whose business model is to create value by fixing broken companies.  Notwithstanding this – indeed perhaps because of it – the company’s strategy was not to invest in R&D but to acquire other drug companies with underpriced products and then hike the prices.  Many pharmaceutical firms have resorted to such financial engineering rather than value creation.

            But the world needs new drugs to save lives and improve their quality, just as pension funds need the portfolio returns that will come from such innovations.  Andrew Lo, a financial economist and professor at MIT’s Sloan School of Management, has posited the creation of an investment fund to cure cancer.  The fund would invest in 100 differing, promising approaches and count on a few paying off big.  Such a fund is needed, he says, because too many corporations are no longer interested in such investments. Instead they sit on big piles of cash, undertake M&A activities, and engage in inversions to change their domicile to other countries with more favorable tax regimes – this despite having benefited from U.S. taxpayers providing funding directly from the NIH and indirectly by huge, unnegotiated drug prices under Medicare and Medicaid.

            This problem of short-term financial engineering over long-term productive investment is not, of course, limited to Pharma.  In one study, 80% of public company CEOs surveyed said they’d pass up making an investment that would fuel a decade’s worth of innovation if it meant they’d miss one quarter of earnings results.

            As journalist Rana Foroohar said:  “Imagine … if 80 percent of doctors said they’d do long-term harm to patients in order to get paid immediately.”

            Even storied innovators are turning to Wall Street to limit their R&D and other long-term investments.  Google recently hired a CFO from an investment bank with the charge of bringing financial discipline to the company’s chaotic, diverse array of early stage ideas and projects.  If cash-rich Google does not innovate, who will?

            But there is an alternative point of view.

            Warren Buffett clearly believes in investing for the long term.  He says several good years of returns is nothing, and that companies should be managed not for short-term profits but for the shareholders who truly stick around for the long haul.

            Steve Jobs once summed up his business philosophy as follows:  “Manage the top line, which is your business strategy, your people – the talent that you have – and your products.  Do all that stuff right, and the bottom line will follow.”

            More and more academic research is affirming that companies focused on sustainability have superior long-term performance.  While market forces push toward the short term, pension funds – almost solely – are the representatives of the long view, demanding sustainable returns on a generational timescale.  The pension trustee is the unique force in the market to make this reality.

Adapted from Opening Remarks at ValueEdge Advisors’ 2016 Public Funds Forum

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