Short vs Long – the Governance of Finance, 2014

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“But I’m judged on performance once a quarter, not once a decade!”

The reaction from fund managers who are assessed every few months against market performance will likely be that short-term losses will trump any associated long-term gains. They have a point. This can only be addressed strategically. But what can change the balance between short and long term performance in favour of the latter?

… they have a point. This can only be addressed strategically

While Transition Investment – Why now? highlights some important longer term trends, these are accompanied by changing paradigms about economics, finance and investment that will change the balance (some new, some turning full-circle). They include a shift in the balance of power towards the ends of the investment chain, the result of various innovations, including cryptocurrencies and peer-to-peer lending and investment, as well as a re-assertion of governance by customers in customer-owned financial institutions.

Moreover, finance is not an island: it sits within a wider governance framework, in turn responsible to society.

The direction of investment is, or should be, influenced by personal responsibility, morals and ethics, by guidance and regulation, by tax, if necessary by the law, and through clarifications and evolutions on aspects such as fiduciary duty (the duty of care to investors and so wider society). These feedback mechanisms will increasingly push change from short term trading towards long term investment, as the consequences of inaction become increasingly apparent. The main issue is whether it will be fast enough.

Ultimately, by definition, financial valuations and wider measures of ‘true value’ will converge: the challenge is to minimise the losses in both by capturing this future ‘true value’ in current financial value.

Engaged investors and financial institutions can already work towards those ends, but to be more effective they need market failures to be addressed. That includes smarter governance frameworks that set clear goals and measure outcomes, but leaves the means of achieving them open.

Governance needs to ensure that market diversity is increased and lower the barriers to entry; it must avoid creating financial entities that are ‘too big to fail’. When those goals are achieved the sector will be able to provide mutual cover for failure rather than rely on tax payers.

Active governance is also required to implementing the fiduciary duty of care for the interests of fund holders (individuals and pension funds) and society more broadly.

Last are the actions by government that indirectly affect the investment environment. That includes creative taxation policies that tax ‘bads’, making tax avoidance a virtue; along with guarantees that help unlock other investment, research funding and the governance of innovation to ensure that needs are met, along with the wider steps that help smooth the way to a some nine or ten billion people living well by the year 2050.

Updated from Future Business, Long Finance, 2014, MMG/SNJ