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Using tuition fees to plug the Universities Superannuation Scheme’s £17.5bn pension deficit is a clear example of how the transfer of wealth from young to old presents a real threat to long-term societal and economic sustainability.  The fact that the Universities Superannuation Scheme (USS) gained an impressive 20.1% in 2016-17 and meaningfully cut costs has been largely overlooked in the press. Focus has instead centred on the growing deficit, which reached £17.5bn, making it the largest pension black hole in the UK. While I can empathise with USS’s dilemma - despite generating 12% returns a year over the last five years, the staggering growth in their liabilities has been largely driven by falling interest rates and lower yields on UK government bonds, factors that are outside the scheme’s control - it raises alarm bells about the long-term prospects for Britain’s economic and societal sustainability. The scheme has yet to make clear how it plans to plug that hole, but in the meantime, experts have pointed to tuition fees as part of the solution. The options being presented are that either fees have to go up, or fees stay the same, but more money is diverted away from teaching to fund the pension promises made to USS’s 390,000-strong academic membership.
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 Investors should be cheering Unilever’s victory over Kraft Heinz and placing a greater value on the kind of corporate sustainability and resilience Polman’s leadership has created. Lessons from other companies should act to warn investors looking for short-term gain to be very careful what they wish for.
The remarkably short-lived take-over attempt by KraftHeinz (KH) of Unilever raises some very interesting questions for investors. What price does focussing on short-term gain extract from shareholders? Unilever’s CEO Paul Polman is well-know for his brand of responsible capitalism, putting long-term sustainability above short-term profit. The Unilever Sustainable Living Plan (USLP) he introduced in 2012 laid out a bold plan to double revenues over a decade while slashing carbon emissions in half. This means moving to sustainable product packaging, wide-spread efficiency gains and ensuring high social and environmental standards across the whole supply chain. The plan should create a positive impact for 5.5 million people, but its impact on Unilever’s bottom line should also catch investors’ eyes. Delivering the goods By April last year, the plan had already led to a saving of 1 million tonnes of CO2 and €100 million through more efficient manufacturing. The company also sent zero waste to landfill across 600 sites in 70 countries, saving a further €200 million. The introduction of compressed deodorant cans reduced the aluminium and propellant gases needed by 25% and 50% respectively. (Polman also waived the patent on the can design to encourage competitors to follow suit.) Over the last five years, under Polman’s leadership, the company’s share price gain has dwarfed that of the FTSE 100.  Tax risk presents a material threat to financial outcomes that investors are largely ignoring.
Stick with me here… I know I’m prone to droning on about the importance of corporate tax in solving the world’s ills, but there is also a very strong risk management angle to this story. It boils down to this: corporate tax risk is a growing threat to financial returns and, by extension, sustainable investment. But it is not being taken seriously enough. New research from MSCI has found that a quarter of companies in their ACWI Index have a large tax gap (531 out of 2,160) and are paying an average rate of 14.3% versus the 31.8% that would be expected based on the jurisdictions where they generated revenue. Furthermore, 71% of those with large tax gaps were multi-nationals. Were the entire gap to be plugged by regulatory reform, the report says, MSCI ACWI Index constituents would have faced additional annual tax liabilities of up to $220 billion in aggregate. $150 billion of that would fall on multi-nationals. This is no small sum. And should serve as a wake-up call to investors who, to date, aren’t paying enough attention to the risks associated with corporate tax. To put this into some kind of context, $2.7 trillion in assets was benchmarked to the MSCI ACWI index family alone in June 2016.  Investors are uniquely placed to engage with government to push for more responsible fiscal policy for the good of the savers they represent. After all, capital cannot sustainably grow without a functioning society. Corporates need to share the burden of funding that society.
Matthew Parris raises some very compelling arguments in his piece in last Saturday’s Times The squeezed middle must pay more tax. He is right that a civilised society makes sure its seniors are at least comfortable and pensions need to be a key focus for government. However, I’m struggling to agree with the headline. More income tax is not the solution to creating a stable, fair society in which businesses and wealth can flourish to the benefit of all. The suggestion that individuals should carry this burden is frankly bewildering given income tax already represents 60% of government revenue in the UK. Workers are increasingly self-reliant for securing their financial futures while the protections they enjoy as employees are going backwards. This breeds discontent towards companies and politicians, neither of which is good for society as a whole. Long-term companies provide superior financial returns, better fundamentals and a more positive impact on the economy and society. Fund managers, in turn, need to take a longer view, exploit the outperformance offered by long-term firms for the benefit of their clients, and encourage more corporates to think long-term.  A few days ago I was chatting to a fund manager at one of the biggest UK fund houses. There was gin involved so I can’t recount the whole conversation word for word, but he did say something that stands out. We were talking about the need for long-term investors to consider the wider implications of their allocation decisions and think long-term – or at least this was what I was banging on about – when he said: “I see a 20 year investment horizon as a collection of 4-5 year investment horizons. There is what we ‘should’ do, and then there is being pragmatic.”
This got me to thinking: Does pragmatism force investors to take a short-term view? Not according to the McKinsey Global Institute. Their report Measuring the Economic Impact of Short-Termism, issued a day after my conversation with this fund manager, summarised the findings of their research thus: “Our new Corporate Horizon Index provides systematic evidence that a long-term approach can lead to superior performance for revenue and earnings, investment, market capitalization, and job creation.” The report rolls from one finding in support of long-termism to another: long-term firms exhibit stronger fundamentals, growing their revenue cumulatively 47% more on average than other companies and in a less volatile manner, allowing them to weather the financial crisis better; they continue to invest in difficult times, spending significantly more on R&D, which helps them maintain consistent and sustainable sources of growth - key goals of long-term planning (see charts below).  Traditional capitalism failed so many for so long because it failed to capture the unintended consequences of how it functioned. We need a more informed version of capitalism, under which investors recognise the wider risks they create in societal and environmental terms and take responsibility for managing those risks.
Last week, while engaging in a little commentary on LinkedIn, I suggested that populism was a growing concern across Europe because ‘our capitalist system has failed so many for so long’. Another member subsequently posed the question: Why has capitalism failed? Europeans/Westerners still enjoy the best standards of living in the world. While I would agree with the latter part of this response, I feel it warrants further exploration. The Davos Paradox: Executives have completely failed to show 'responsive and responsible leadership'18/1/2017  Executive pay is a clear indication that top executives are failing shareholders and employees. The theme of this year's World Economic Forum of 'responsive and responsible leadership' appears somewhat paradoxical in the context of the widening inequality gap between the wages of top executives and their own employees.
I often struggle to find affinity with the Daily Mail, but every now and then something catches my eye. Hugo Duncan’s piece on 16 January about a group of UK CEOs, who collectively earned £145 million in 2015, flying to Davos to tackle poverty, was one such piece (read it here). It does seem rather paradoxical. After all, the theme of this year’s World Economic Forum is ‘responsive and responsible leadership’. This group of CEOs have proven to be neither responsive nor responsible when it comes to their own pay packages. Recent years have seen a good number of shareholder rebellions over fat-cat pay including (but in on way limited to) Martin Sorrell’s £70.4 million award (WPP) and Bob Dudley’s £16.1 million pay deal (BP). Yet, despite those calls for restraint from some of the leading global investment houses and the UK government, CEOs continue to enjoy exorbitant increases in pay.  It has long been held as gospel that cutting corporate tax fuels investment and growth. However, without fundamental reform, business tax cuts may hinder rather than boost economic progress and investors can ill afford to ignore the consequences.
Governments, in their efforts to boost domestic economies, are offering tax cuts left, right and centre. Brexit-bound Britain, for example, saw its Prime Minister, Theresa May, promise to cut business tax to the lowest level in the G20. President-elect Donald Trump has also promised to cut corporate tax rates. The main reason for the ‘race to the bottom’ in corporate tax? That attracting companies to locate their operations in a country will mean growth and prosperity for those who live there (and vote there). But does it really work?  If we don’t start to adapt our policies, economies and investment approaches to address the widening gap between the haves and the have-nots, the likely political, societal and financial market ramifications will make Brexit and Trump’s election success look like child’s play.
Rifling through a box of old bits and bobs over the weekend I found my old film camera. Boy, did that bring back some memories, but it also got me thinking: even within my short (ok, short-ish) lifetime, technology has had the most profound impact on how our societies function. I remember buying Kodak films, which I then had to take to a shop to be processed. From purchase to printed product, I typically interacted with at least three people employed to service this hobby. There were of course countless others I never saw. Where have those jobs gone now? Kodak went from employing 170,000 people to being bankrupt within a few years. And they won’t be the last. Amazon has tolled the death bell for many a high-street brand. How many hotels have been threatened by the Airbnb revolution and what happens to all the people employed in the hospitality sector as margins are squeezed ever tighter? Uber has completely changed the face of taxi services across the globe and, with driverless cars just around the corner, how many more jobs will be lost in that and other transport-related sectors in the coming years and decades? Can the big traditional car companies survive the shift? What happens to all those jobs – and the people doing them?  Traditional capitalism failed so many for so long because it failed to capture the unintended consequences of how it functioned. We need a more informed version of capitalism, under which investors recognise the wider risks they create in societal and environmental terms and take responsibility for managing those risks.
Last week, while engaging in a little commentary on LinkedIn, I suggested that populism was a growing concern across Europe because ‘our capitalist system has failed so many for so long’. Another member subsequently posed the question: Why has capitalism failed? Europeans/Westerners still enjoy the best standards of living in the world. While I would agree with the latter part of this response, I feel it warrants further exploration. Simply put, my answer to this question is that traditional capitalism failed so many for so long because it failed to capture the unintended consequences of how it functioned. Instead, capitalism has focussed almost exclusively on financial return. Capitalism, at its heart, is about investment – allocating capital in order to increase that capital. It is an absolutely essential part of what makes economies and societies work, but capital cannot exist in a bubble measured only in financial terms. Every investment, whether in extractive industry stocks, green bonds, property or even handbags, has a much wider impact on the economy, society and the environment. Unless that wider context is considered, financial returns become almost meaningless. (What good is a 50% return on a pension pot, for example, if our collective global investment decisions have driven up the cost of living by 60%?) Because traditional capitalism has largely ignored those unintended consequences (risks, by another name), we have ended up in a world where inequality is growing, our climate is changing rapidly to our detriment, companies are not being held to account and populations are not adequately prepared for greater automation. (Governments and central banks have a lot to answer for too, but those subjects will be covered in future posts.) The narrow focus of traditional capitalism may also, ironically, end up being its undoing as financial returns become unsustainable. Risks ignored are risks that build and eventually come back to bite. Those issues, particularly inequality and global warming, are already manifesting themselves in the financial rewards the traditional capitalist approach was meant to generate. But, rather than driving returns up, they are doing the opposite. MSCI, for example, calculated mid-last year that the spread of populism through Europe and the US over the next two years could result in heavy financial losses. Under their scenario, one outcome may be a lowering of global growth by 3% annually while inflation surges. The potential damage this would wreak on a diversified, multi-asset class portfolio could be a decline of over 11% as equities lose 15.6% and fixed income securities fall 4.6% (although I suspect Trump’s first week in office, and the financial market response to that, could mean the outcome of MSCI’s scenario may look considerably worse now). The lack of credible and standardised metrics to capture and measure the unintended consequences of investment is at least part of the reason why so many of those risks have not been recognised or managed. This works at the policy level too. I can’t help thinking though, that if the traditional capitalist model has been more open-minded, those metrics would have been found long ago. And, even where they do exit (data showing growing inequality has existed for some time now), they have still been ignored. As Andrew McNally points out in his book, Debtonator: Since the 1970s the Western World has seen the most prolonged rise in inequality, both in income and wealth, since the 1800s. So while we in the West might still be enjoying the best standards of living globally at the holistic level, the picture is far from simple and the risks to those living standards continue to build. What we need now is a more informed version of capitalism, under which investors – and by this I mean anyone who makes decisions about how capital is allocated – recognise the wider risks they create in societal and environmental terms and take responsibility for managing those risks. This includes lobbying government and central banks to push the policy agenda in the right direction. We desperately need better, more standardised and credible metrics to measure societal and environmental impact so those risks can be robustly analysed and managed, and can begin to take their rightful place alongside financial returns in judging how successful an investment has been. But we also cannot ignore the warning signs that are already flashing before our eyes. (Debate is an absolutely essential part of finding solutions to the challenges we face. Please don't hesitate to post your thoughts below if you like or dislike this perspective, but also if you want to share your own thoughts on how we can address those challenges.) |
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