Mandates for long-term change: why insto rules need a rewrite

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A new paper, involving researchers across disciplines and firms, argues the ‘institutional manager mandate’ is due for a redesign to meet the aims of long-term investors. The report recommends a new set of standards among big institutional investors.

The ‘Focusing Capital on the Long Term (FCLT) Global’ report released last week says the mandate rewrite would update a range of standard terms and conditions including fees, benchmarks and reporting to better align the relationship between asset owners and fund managers.

“By incorporating long-term objectives into the initial contract itself, owners and managers can help ensure fruitful investment partnerships that both satisfy their needs and support the productive long-term allocation of capital across the investment value chain,” the study says.

The report highlights nine specific mandate details for institutional investors to ponder offering a “menu of choices” for each item as well as new ways to assess managers around five key performance indicators (KPIs).

Fees, for example, could be discounted reference to the length of a contract rather than simply based on mandate size, the report says.

“A discount based on longevity of the relationship may provide a longer-term incentive for them,” the FCLT study says. “An owner receives a benefit for patience and continuing commitment, while the manager benefits from the comfort of a more reliable capital commitment, both of which may help them capture long-term premia.”

The report says performance fee agreements centred on multi-year calculation periods, compounding hurdle rates, and, deferred payment should also be on the mandate agenda.

“Deferring such a [performance]fee, rather than paying it and clawing it back in the case of future underperformance, lessens the possibility that the manager will become overly risk-averse during the later years of the contract,” the paper says.

The ‘Institutional Investment Mandates: Anchors for Long-term Performance’ study suggests longer fixed contract terms – as opposed to the standard fire at will conditions – could further improve the long-run alignment between asset owners and managers.

“Setting a three- to five-year term with automatic renewals—provided that the asset manager continues to act in the best interests of the asset owners—may build the relationship with a long-term timeframe in mind, shifting the onus from reacting to short-term performance to evaluating progress towards long-term goals,” the report says. “These contracts may still offer wide discretion for termination, in contrast to strict lock-ups, so that asset owners can make the decision to terminate if circumstances warrant.”

While the FCLT report says long-term benchmarks remain problematic – and a secondary factor in aligning behaviours – how the yardstick was employed and its reference time-frame were more important than the specific index selected.

However, the paper suggests other metrics such as absolute returns or “engagement” with underlying companies could be included in mandate conditions.

“Would alternate benchmarks that explicitly incorporate long-term thinking, such as the S&P Long Term Value Creation Index or the asset owner’s discount rate, be effective in encouraging long-term behavior?” the report says.

A panel of over 20 experts, including NZ Superannuation Fund (NZS) manager external investments, Rishab Sethi, contributed to the FCLT study.

FCLTGlobal was founded in 2013 under the aegis of a handful of organisations including BlackRock, the Canada Pension Plan and McKinsey. The group devoted to “rebalancing investment and business decision-making towards the long-term objectives of funding economic growth and creating future savings” today boasts over 30 members including the NZ and Australia’s Future Fund.

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