A long history of short-termism

In: Uncategorized

6 Aug 2012

This is my latest Perspective column for Fund Strategy. It is more technical than normal.

Given the pressing problems facing the British economy it is all too easy to focus on the short-term rather than take a longer view. Such temptations should be resisted.?A longer-term perspective does not preclude taking urgent measures. The challenge, however, is to work out how to move towards stronger and more durable economic growth.

The government acknowledges short-termism as a problem and would argue it is taking action too. Last month the Department for Business, Innovation and Skills (BIS) published the Kay Review of UK Equity Markets*. This project in turn followed an earlier consultation exercise aimed at developing “A long-term focus for corporate Britain”.

For anyone interested in financial markets and the asset management industry the Kay Review is well worth a read. Professor John Kay, an economist and Financial Times columnist, has distilled many of the key trends from a mass of specialist material and consultations with experts. For example, in relation to equity market he shows how, on balance, companies are withdrawing capital rather than using it as a source for funds.

Kay also shows how the structure of equity ownership has changed dramatically with individual shareholding becoming much less important while overseas holders have grown enormously (see graphic). But on a cautionary note he points out that American-owned asset managers that manage assets for British clients are classified as “foreign”. So funds managed by BlackRock, Capital, Fidelity and Vanguard are classified as international although they are in many senses British.

However, when it comes to recommendations the report is bland. The focus is on improving the stewardship of companies. To achieve this goal Kay advocates various good practice statements and codes while urging companies to take a more long-termist view. Among the other recommendations is a requirement that fund managers disclose their costs and that all income from stock lending should be disclosed and rebated to investors.

Whatever the merits of these and other proposals it is hard to see how they can have much bearing on the key challenge. For instance, there may be a strong case for making fund management more transparent but it does not follow this would help bolster economic growth. It would be far better if the two goals were clearly demarcated.

The fault is really in the brief given by Vince Cable, the minister in charge of BIS, and embodied in Kay’s terms of reference. Cable’s narrow perspective itself precluded asking some of the most important questions on the topic. This is apparent from the speech he gave to the Association of British Insurers in June 2011 in which he announced the formation of the Kay review.

Perhaps the biggest error in his speech is to assume that the rise of short-termism in the financial markets has caused Britain’s poor record of low business investment. He ruled out from the start another, more disturbing possibility.

There is a strong case that the causality goes in the opposite direction. In other words poor economic performance has caused financial markets to become more short-termist. From this perspective the primary challenge is to address the weakness of the real economy.

There may be a moral case to improve various financial practices, such as fee disclosure, but such measures are unlikely to bolster the economy.

Cable also underestimates the problem of short-termism both in terms of its hold and its duration. He suggests it is a newish development, perhaps going back a decade, which the government has decided to tackle.

I am acutely aware that the problem has a longer history as I had a book on the subject, Cowardly Capitalism, published back in 2001. For example, back then I talked about the debate on short-termism and about how the stockmarkets were no longer net providers of capital.

I claim no special prescience in having written about this subject over a decade ago. Back then the financial media had already discussed the problem for some time. For instance, back in 1999 one of the FT’s investment experts wrote that: “Britain stock market has almost ceased to function as a primary market channeling capital to the corporate sector” (Barry Riley “Out of the public gaze” FT April 24, 1999).

In reality the problem of short-termism in the British economy goes back at least three decades. It also involves politicians as much as corporate boards and fund managers. Politicians have preferred to shore up the economy by keeping public spending artificially high rather than promoting economic restructuring.

Finally, Cable seems unaware of the strong cultural factors holding back economic prosperity. This is a trend I have referred to elsewhere as growth scepticism. It takes the form of a sense that any moves towards prosperity need to be wary of environmental, moral and social limits. It is essentially an ultra-cautious approach to development.

Many of the measures proposed in the Kay review are only likely to strengthen this culture of caution. The last thing businesses need is more codes of practice and regulation to follow. It is not that all regulations are bad. Rather that the character and sheer quantity of current regulation reinforces the climate of excessive caution.

The government can commission as many expert reports as it likes but in itself this will not address the problem of short-termism. If the government wants to do something positive the first step should be to overturn its own short-termist mindset and address the weaknesses in the real economy. Rather than pass responsibility on to others it should take a lead itself.

* The Kay Review of UK Equity Markets and Long-Term Decision Making. Final Report. July 2012.