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McKinsey Long-Term Capital 2014

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  • 1. McKinsey & Company | 15 Dominic Barton Global Managing Director, McKinsey & Company March 26, 2014 Focusing Capital on the Long Term
  • 2. McKinsey & Company | 1 Topics for discussion 1 2 3 4 ▪ The rise of short-termism ▪ The importance of long-term thinking ▪ The role of boards ▪ Practical changes for asset owners
  • 3. McKinsey & Company | Five mega-trends reshaping the global economy Resource scarcity The market state The rise of emerging markets The Digital Age Aging populations1 2 3 4 5
  • 4. McKinsey & Company | 3 A call to action Capitalism for The Long Term March 2011 Focusing Capital on the Long Term January 2014
  • 5. McKinsey & Company | 4 Short-term pressures are escalating 73% say that they should use a time horizon of more than 3 years 55% of CFOs will reject an NPV-positive investment if it means missing next quarter’s earnings targets Average duration of London Stock Exchange holdings fell from 5 years in 1966 to only 8 months in 20071 Average CEO tenure has dropped to < 7 years today from 10 years in 1995, and < 5 years for Fortune 500 CEOs Of 1,000+ surveyed C-suite executives and board members, 44% use a time horizon of less than 3 years in setting strategy 63% say that the pressure has increased over the past five years to generate short term to results 2011 2012 2013 2014 2013 2014 1 Similar trends exist in the US – average duration of NYSE stock holdings has fallen from 6 years in 1975 to only 7 months in 2009
  • 6. McKinsey & Company | 5 It took P&G, Coca-Cola and Walmart 8-11 years to become profitable in China Intel abandoned manufacturing memory chips in 1985 to focus on microprocessors Long-term thinking is essential for long-term success Apple’s share price fell 25% the year the first iPod was released 86% executives agree that a longer time horizon for business decisions would improve corporate performance 70-90% of a company’s value is related to cash flows 3+ years out
  • 7. McKinsey & Company | 6 Practical changes for asset owners Structure institutional governance to support a long- term approach (e.g., Norges Bank Investment Management maintained its long-term strategy through volatile equity markets) 4 Unlock value through engagement and active ownership (e.g., Larry Fink encourages companies to work directly with BlackRock and other shareholders, rather than focusing on winning over proxy advisory firms) 2 Define long-term objectives and risk appetite (e.g., GIC maintains a 20-year time horizon for value creation) 1 Demand long-term metrics (e.g., Puma developed environmental and social impact “P&Ls”, Natura publishes sales force satisfaction and turnover metrics) 3
  • 8. McKinsey & Company | 7 Several large asset owners have taken steps towards setting longer horizons for their investments 1. DEFINE LONG-TERM OBJECTIVES AND RISK APPETITE The Ontario Teachers’ Pension Plan has been a leader in allocating capital to illiquid long-term assets – today 23% of its portfolio is in real assets (e.g., water utilities, retail and office building) GIC, Singapore’s sovereign wealth fund maintains a publicly-stated 20-year time horizon for value creation, deliberately investing up to a third of its portfolios in companies in volatile emerging Asian markets Berkshire Hathaway uses the rolling five-year average performance of the S&P 500 (rather than annual returns) as its benchmark to signal its longer-term focus (benchmark is less impacted by year-to-year volatility) The Canadian Pension Plan Investment Board is experimenting with innovative ideas to encourage a longer-term outlook with its investment professionals (e.g., committing capital for 3 years, basing performance-based payments on long-term track records, rather than annually)
  • 9. McKinsey & Company | 8 The Equity Engagement Spectrum 2. UNLOCK VALUE THROUGH ENGAGEMENT AND ACTIVE OWNERSHIP Ownership stake in company <2% 1-5% >10% Ongoing engagement ▪ Continuously monitors companies – both reacting to performance and providing ongoing input ▪ May build micro-coalitions with other investors Active ownership ▪ Works publicly or privately to persuade the board and management to change long-term strategy ▪ Tries to build micro- coalitions with other investors Relationship investing ▪ Works collaboratively with management on long-term strategy ▪ Often has board seats CalPERS screens its portfolio to identify companies that have underperformed and works with them to improve their strategy and governance
  • 10. McKinsey & Company | 9 Asset owners should encourage companies to publish metrics that are truly material to long-term value creation 3. DEMAND LONG-TERM METRICS Unilever’s long- term plan for sustainable growth calls for doubling sales in 10 years while halving its environmental impact and enhancing the livelihoods of people along its value chain Puma developed an “environmental P&L” in 2011 and is developing a “social impact P&L” to be included in its annual reports – to show investors that it understands and is managing the risks of its supply chain Philips issued its first sustainability report in 1998 and its first integrated financial, environmental and social report in 2008, including information like employee satisfaction and resource productivity Natura, a Brazilian cosmetics company, is scaling its door- to-door sales strategy while publishing metrics to show investors that it has not compromised on quality (e.g., sales force turnover, training hours, satisfaction) to help investors)
  • 11. McKinsey & Company | 10 Norges Bank Investment Management (NBIM)’s strong governance allowed it to continue on its long-term path despite volatile equity markets 4. STRUCTURE INSTITUTIONAL GOVERNANCE TO SUPPORT A LONG-TERM APPROACH The Ministry of Finance in Norway and NBIM set a long-term goal to raise the equity content of the fund from 40% to 60% NBIM lost 40% of the value of its global equity portfolio during the financial crisis and faced high external pressure not to buy back into the falling market Its strong governance1 allowed NBIM to allocate all $61B of inflows in 2008 into buying equities, making a 34% return in 2009 and outperforming the equity rebound Has employed a similar counter- cyclical strategy since – turning an equity loss of 9% in 2011 into an 18% return in 2012 2007 2008 – 2009 2009 - Present 1 Arms-length relationship between NBIM and the Treasury along with strong Board leadership allowed NBIM to stick to its investment principles
  • 12. McKinsey & Company | 11 The role of boards in shifting to a longer-term mindset Boards of directors need to … Spend more time (e.g., directors of public companies devote only 12-20 days per year to their duties, compared to 54 days for private equity-owned companies) Focus more on long- term strategy (e.g., 75- 80% of directors’ time is spent on fiduciary issues, while only 4% of companies have a long- term strategy committee) Have more relevant experience (4 of 5 non-executive directors of large companies lack industry knowledge) 46% of executives named their board as a significant source of increased pressure to demonstrate short- term performance over the past 5 years
  • 13. McKinsey & Company | 12 The Focusing Capital on the Long Term initiative is intended to generate practical recommendations for tackling short-termism The objectives of the Focusing Capital on the Long Term initiative are: Identify practical recommendations to focus business and markets on the long term Work together to encourage their adoption both within our organizations and others’ We will seek to differentiate our efforts, as compared to the work underway by other institutions/initiatives, by taking an action-oriented, pragmatic approach: Bring together leaders from both the investment and corporate worlds to share and discuss perspectives from all parts of the investment value chain Focus on practical ideas that can be implemented today Generate broad awareness and debate around our ideas in the business and investment community through a strong advocacy and communications platform 1 2 1 2 3 FOCUSING CAPITAL ON THE LONG TERM INITIATIVE
  • 14. McKinsey & Company | 13 Our working group is comprised of institutional investors, asset owners / managers, corporations and academics FOCUSING CAPITAL ON THE LONG TERM INITIATIVE Institutional Investors Asset owners/ managers Nitin Nohria Dean, Harvard Business School Paul Polman CEO, Unilever Cyrus Mistry Chairman, Tata Dominic Barton, Co-Chair Global Managing Director, McKinsey Sir David Walker Chairman, Barclays Peter Sands Group CEO, Standard CharteredCorporations Academics Angelien Kemna CIO, APG Lim Chow Kiat Group Chief Investment Officer, GIC Adrian Orr CEO, NZSF Wayne Kozun SVP, Fixed Income and Alternative Investments, OTPP Michael Sabia President and CEO, CDPQ Danny Truell CIO, Wellcome Trust Theresa Whitmarsh Executive Director, WSIB Mark Wiseman, Co-Chair President & CEO, CPPIB Henri de Castries CEO, AXA Larry Fink CEO, BlackRock Lynn Forester de Rothschild Chief Executive, EL Rothschild Ronald O’Hanley Fmr. President, Asset Management and Corporate Services, Fidelity Empirical academic team led by Josh Lerner, Harvard Business School We will also convene a group of Senior Experts to provide expertise in particular subject areas Richard Edelman President and CEO, Edelman Euan Munro CEO, Aviva Investors
  • 15. McKinsey & Company | 14 We will be pushing our members to explore a number of practical actions that can be taken as a group to tackle short-term thinking FOCUSING CAPITAL ON THE LONG TERM INITIATIVE Board focus ▪ Pay non-executive directors for at least 40 days work per year ▪ Review the proportion of Board time spent on long-term issues, and explore whether a long-term health committee would help increase the amount Reorient portfolio ▪ Use a portion of new asset manager mandates to pilot a range of longer-term incentives and evaluations Investor-corporate dialogue ▪ Commit to highlight 5 long-term metrics that are material to the long-term health of the business model in earnings calls and annual reports ▪ Discontinue quarterly earning guidance by 2015 Engagement ▪ Set up a collaborative engagement platform and test it by engaging with companies on executives' long-term incentive plans
  • 16. McKinsey & Company | 15 We have already developed a significant research base and have begun to speak and write publicly about the initiative and our insights Conducted a McKinsey Quarterly Survey of over 1,000 global executives and board members on the causes of short-termism Conducted in-depth analysis on the causes of short-termism and potential solutions Several public speeches including to the Canadian Institute of Corporate Directors Harvard Business Review article ‘Focusing Capital on the Long Term’ published in Jan/Feb 2014 edition www.FCLT.org launched to communicate our thinking FOCUSING CAPITAL ON THE LONG TERM INITIATIVE