Supporting UK productivity with long-term investment
The Investment Association calls for an industry-wide rewiring of incentives towards the long-term allocation of capital, to drive growth and productivity in the UK economy.
Productivity in the UK is well below trend, and investors - the allocators of capital - are primed to improve it. This was the overarching message from the guest speakers and panel at an Investment Association event on Tuesday evening.
The event served to introduce an Investment Association report - Supporting UK Productivity with Long-Term Investment - which includes 12 recommendations for companies, investors and to a lesser extent the Government, to improve productivity in the UK.
Central to the report’s proposals are changes to company reporting, enhancing dialogue between actors in the investment chain, correcting tax incentives and other measures that warp behaviour towards short-term goals, and ultimately fostering more long-term, value-adding capital allocation.
The guest speaker, Commercial Secretary to the Treasury Lord O’Neill, opened the event with an appraisal of the report and signals at the Government’s intentions:
“Speaking on behalf of the Government and the Chancellor, we very much welcome the commitments that your report outlines: the discouraging of quarterly reports within it - ideas about reporting on firm-level productivity strikes us as a very interesting thing to do - and I’m sure many of you are more than aware, there are all sorts of dilemmas as to whether we are measuring productivity at all well in the modern complex world.”
He added: “If you read carefully the amount of words that we put into the Budget document about what I loosely call ‘long-termism, they are on the increase, which is a deliberate sign of the importance which we attach to it.”
Andrew Ninian, the association’s Director of Corporate Governance and Engagement, stressed the importance of improving company reporting. “We’re calling for the removal of quarterly reporting to focus on longer-term reporting - on the drivers of productivity,” he said. “We hear too often companies are focusing on their next quarterly announcement, rather than raising their heads and thinking about how they’re managing their business for the long-term.”
Nicholas Cadbury, Group Finance Director of Whitbread Plc, owner of Premier Inn and Costa Coffee, offered a compelling testament to this view. He argued that in a capital intensive industry such as hotels, where investing in human capital is paramount, long-term financing is both essential, and wholly contradicted by the ‘the drum beat of quarterly reporting.’
Another central recommendation is simply for more communication between companies and investors; for companies to be more articulate about how capital is being allocated and for investors to support them through those processes. But also for investors to be more articulate about their expected return on capital, the absence of which produces value-extracting behaviour.
“We hear far too often that investors are not being articulate about their expected return on capital,” said Ninian. “And companies are mistaking that by returning capital through dividends or share buybacks, rather than investing for the long-term.”
Dorothy Thompson, chief executive of Drax Plc provided another example of how clear expectations had fostered investor support and ultimately delivered a project that was “efficient, on time and to budget.”
Drax now provides 4% of the UK’s electricity through compressed wood pellets, and was the first company in the world to utilise this renewable source of energy. The project required £700m in finance, but thanks to a comprehensive capital programme of clear targets, “People came to us,” she said.
“We could not have done it if we hadn’t had the support of our core investors who have backed us at every stage of this very complicated project, so I’m a very firm believer in the recommendations of this report.”
The report also suggests more open dialogue between players in the investment chain, improving long-term investors’ access to capital markets and ensuring the cost of issuing new equity is as efficient as possible. All of which is aimed at fostering a culture of long-termism, and equity financing over debt.
Similarly, in terms of tax and regulatory impediments, the authors of the report and much of the panel felt that recent changes in the tax regime created a ‘debt bias,’ while solvency and risk regulations were in many cases disincentivising long-term investments.
As Richard Buxton, chief executive at Old Mutual Global Investors, put it: “There is clear evidence that regulation - both for insurance companies and pension funds - has ended up having procyclical consequences that have herded people into ever greater levels of financing things with debt, and away from [equity] which actually could have been really helpful structurally for the growth of the economy.”
Simon Gergel, CIO of UK Equities, Allianz Global Investors, summarised that the plan is essentially about changing the method of measurement. He used an example from particle physics - Heisenberg’s Uncertainty Principle - which states that as you try to observe and measure a particle, you change its behaviour:
“I think that’s quite intrinsic to this whole review: the way you measure people, the way you measure organisations, affects their behaviour. You see this all the way through the investment chain, starting at the very top, the way pensions funds accounting and solvency works has prompted them to take a lot of money out of equities and put it into bonds.
“The way those pension fund trustees judge their own performance affects the mandates they give to asset managers, affects the type of consultants they employ and the time scales they look at. And again this affects us, as fund managers: the time scales we look at, the type of risk calculations we use, the type of investments we make and the policies we follow.
“The plan overall,” he concluded, “is to take a holistic view to these issues, trying to bring them together, to investigate how this works and move the debate forward. It doesn’t have all the answers, but poses a lot of good questions.”
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