Canada's largest pension fund is calling for investors to put their money in companies that don't bow to the pressures of short-term decision making, and then ride out any market volatility that follows.
Canada Pension Plan Investment Board has teamed up with S&P Dow Jones Indices to track businesses with the potential to deliver returns over the long haul, with the ambitious plan to influence other companies to adopt better governance and business practices. Several institutions have signed on to invest in the new S&P Long-Term Value Creation Global Index, and CPPIB expects retail investors will soon gain access through funds.
"What we've been witnessing, particularly since the financial crisis, is a situation where corporate decision-making in order to meet quarterly earnings targets, in order to placate activist investors, in order to at times comply with certain regulatory conditions … is eroding, instead of creating, shareholder value," said Mark Wiseman, chief executive officer of CPPIB, on the phone from the World Economic Forum in Davos, Switzerland. The pension fund has long campaigned to get more investors to look past quarterly reporting.
Major Canadian pension funds often tout their ability to hold onto assets for long periods of time as one of their key attributes. Because of their long-dated liabilities – meaning pensions that need to be paid far in the future – these funds can outlast other investors.
But some large institutional investors, including CPPIB, are increasingly concerned about "short-termism" in the capital markets – the kind of investing that puts the emphasis on making decisions that favour quick profits, rather than emphasizing future objectives.
Mr. Wiseman said this behaviour can have an impact on the returns CPPIB and other major investors can earn.
Some of that thinking contributed to the global market declines on Wednesday, Mr. Wiseman said, adding that markets have a tendency to overreact. Sometimes, that's because "investors are paying too much attention to short-term views that really will not have a long-term impact on the value of an enterprise," he said.
CPPIB and several other institutional investors from around the world are so sure the new index will work that they will "put their money where their mouth is," Mr. Wiseman said. CPPIB will be selling down part of its existing passive holdings to move the money and invest in the index. The pension fund and some other undisclosed investors are allocating an initial $2-billion (U.S.) into funds tracking the index as a show of confidence in the formula.
Among those that say they support the initiative are the Ontario Teachers' Pension Plan and Singapore's investment fund GIC.
The public companies on the index are selected for their ability to keep their competitive advantages and the probability that they will deliver long-term value for their shareholders as judged by several qualitative and quantitative factors.
Businesses are assessed not only on their earnings, balance sheets and profitability, but also on their corporate governance as mapped out by sustainable investing firm RobecoSAM. This includes assessing management incentives, board independence and crisis-management abilities. Business ethics and customer relationships also factor in.
CPPIB believes the index will outperform over the next decade, but also thinks it could affect corporate behaviours. As more people invest capital in the index, "other companies who aren't in the index, we hope, will review their practices [and] reform their practices," Mr. Wiseman said.
He added that some asset managers could create ETFs that track the index for retail investors in the future.
The index is currently comprised of nearly 250 companies across 19 developed countries including Canada, as well as six emerging markets. The United States accounts for about 40 per cent of the geographic investment weighting.
Canadian companies that made the index include stalwarts such as Royal Bank of Canada and both Canadian National Railway and Canadian Pacific Railway. It also includes some natural-resource names such as oil and gas producer Arc Resources Ltd., Goldcorp Inc. and Teck Resources Ltd.