Carol Geremia is President of MFS Investment Management, which manages about US$450 billion with headquarters in Boston, USA. She has worked at MFS for 35 years and has seen many investment cycles play out.
GH: You have written about misalignments in the asset management industry. What is the most important the industry is now facing?
CG: The most obvious one is what active managers say is their main goal - to outperform over a full market cycle – and what the industry has actually anchored around.
The industry focusses around three to five years, more towards three and arguably even one year. We’ve confirmed this with global studies to check perceptions. But against this, a full market cycle is much closer to seven to 10 years, and now we're in this extended bull market that’s going even longer.
GH: It’s already over 10 years since the 2009 bottom.
CG: Yes. If you're a long-term active manager, and your purpose, first and foremost, is to put money to work responsibly, to allocate capital responsibly, that is what will create value over time on a long-term asset. But people don't understand the full market cycle of peak to peak or trough to trough. It must include the bull and the bear, it's not just one side. So we’ve already started off from a place of misalignment.
Active managers have thrown this out the window and said, “Nobody's giving me the time, so let's not even talk about it.” That’s the most acute misalignment.
GH: And you put the blame on the industry rather than investors?
CG: We try to micromanage the debate but I worry that it translates into a blame game. We haven't had enough aligned conversations on the subject of time. Fund managers are under so much pressure to deliver alpha (Ed, returns above the index), that even when everybody's making money, if managers don't generate alpha, it almost feels like they've lost somebody's money. But most haven't even come close.
GH: Yes, with the market up strongly over the last decade, investors have had a good time.
CG: We need some different performance metrics, because outperforming a price momentum biased benchmark all the time is not what investors should pay for.
GH: And focussing only on performance and not on risk.
CG: That's the whole point. At some point, if an investor picks an active manager, they really should watch if they have counter-cyclical skills. Can they go against the grain at the right time? There's a lot of concern now that pro-cyclicality is happening. It's chasing past performance and shorter and shorter periods of time, and that will cost end investors.
GH: And some value managers feel they must chase growth stocks at what is probably the wrong time.
CG: And it becomes this style game, active versus passive and hiring and firing active managers, all at the wrong time. The industry can do better than that.
GH: One of the changes you are making which I like is in the way you set out your performance tables, putting the long-term numbers first. The first column is the 10-year number. In fact, today I saw a presentation where the manager showed their one-month number first.
CG: Putting long term first is not a unique idea, but the beauty of it is not only the measurement itself, it's the opportunity for a dialogue with the client. It leads to a discussion on greater trust, clarity, transparency and understanding. They might ask, “Why are you talking to me about the 10-year number?” And we can say, “Well, even though my one-year number is good, I want us to manage the expectation that the 10-year number is more realistic.”
In my career, I came out from the fiduciary world of the 401k business (Ed, retirement plans in the US). I ran that for about 20 years at MFS, and we changed our statements to start with the 10-year number in the retirement plans. It helped with client conversations. We realised when we did education sitting with company employees, and said, “Here's a stock, here's a bond, here are your 30 options,” it was just confusing for them. So we realised, okay, what can we tell them that really helps? And the most common question was, “How much risk should I take?”
GH: What’s the response to that question, whether to a retail investor or institution?
CG: My only answer is, “Tell me how much time you have.” We used to call it risk tolerance but it’s really time tolerance.
Finishing that point on the statements, we did that in the late 1990s when the market was rocketing up, and we were worried that people were taking too much risk to chase the returns versus realistic long-term expectations.
GH: Within your own company, how do you create the right long-term thinking when people are paid bonuses each year and in all personal lives, everyone has both short-term and long-term needs and goals?
CG: You absolutely must, and it starts with a culture that values a long-term view. And I don't say that lightly and we even say loyalty is important. And when people say, well, in today's world, loyalty might mean complacency, my response is that loyalty at the best firms in the world is probably the number one attribute. It's not complacency. It's the values that having a long-term view is the right thing to do if you're caring for something that's not yours.
So that must be real. You can change remuneration, for example, we don't pay bonuses on one-year numbers. In fact, we pay on the longest track record that somebody has. You must watch the incentive misalignment. You can’t expect people to run money with a long view if you drive short-term incentives. And you must run the business that way too, which sometimes means short-term pain. But I do think the culture piece is the hardest. You must believe it.
GH: MFS is an active manager, and in Australia at the moment, including in the media and by the regulators, there’s a strong focus on fees rather than net performance or risk. And it's fair to say that the active managers are losing the passive versus active argument in the public domain. How can the active managers fight back?
CG: We have to, but do it in a way that is not self serving. I'm cautious about conversations that involve self reflection. Here's the thing. Over what period of time are you measuring active manager performance? That’s my first question. The good managers deliver over the long term, and we have the data to show it.
But I actually think the comparison is a good thing. The investment industry is managing US$100 trillion globally. That's a lot of money to oversee and a lot of people to serve. I think that the growth of passive is to the benefit to active management, as it will weed out the mediocrity that is in the system right now.
GH: We’re certainly seeing plenty of fund managers leaving the industry.
CG: But the second piece is it will define more clearly why investors pay an active manager and what they are paying for. People pay for quality, but what is quality in the investment business? I know when I buy a quality jacket, I can tell it's been well made. What is it in investing? I say it's responsibility, putting money to work responsibly in this system?
By the way, the public markets are under massive threat. If we don't take care of public markets, the whole system, we've got much bigger problems than passive versus active. We as an industry in active management, if we say we're long term, we must prove it. Conviction is not only position, size or concentration. Conviction should be capital commitment to great underlying businesses that will create value for shareholders, and the whole system, communities, employees. The debate is more about shareholder versus stakeholder and the efficiency of capital allocation.
There's a lot of capacity chasing risk right now and active and passive can work together. Investors pay active management a premium to hold corporations accountable with true engagement, way beyond proxy voting.
GH: What types of engagement, other than proxy voting?
CG: There’s tons of it. You embrace understanding the business and its competitive dynamics. You talk to management about what you think they do well or don't do well. You ask them about their long-term strategy. Proxy voting is important but it’s only one piece of the pie.
GH: You've had various roles in MFS over 34 years. Can you identify one good change about the the asset management industry, and one unwelcome change?
CG: The best thing that has happened is the democratisation of investing. As much as we beat each other up, the amount of long-term savings and wealth that has been created is considerable. Now, I'm very sensitive that the distribution of that wealth is quite warped, but investors who did not even know what a stock was in the past now have easy access to invest.
GH: That's the plus, what’s the minus?
CG: The exact flip side of that is the amount of communication, education, responsibility and obligation we need to get this right. To fight against the misalignments that have crept into the system. About 80% of public markets is now owned by institutions, the mutual funds, superannuation funds, pension plans. But 25 years ago, that was 30%. We have this long chain of intermediation which creates agency issues amongst ourselves.
But we're trying to micromanage each other and hold each other accountable so much that we can forget about what it means to the end investor. We have to improve communication because investors are now taking five times the amount of risk to get the same return than they did 15 years ago. We must talk to them about extending the investment horizon and it's not because we want to get paid longer. We are taking risks with their money and they must understand.
GH: Here’s my one macro question. Do you think the massive expansion of central bank balance sheets and injection of trillions of dollars of liquidity will end badly at some stage?
CG: Well, I like to be an optimist, but the market is very distorted. I understand the importance of keeping the economy growing, but at some point, we must come up with a better strategy. I think we can because it's amazing the things that we can do.
GH: If you think about all the trends in the world, such as demographics, climate change, the aging population, technology. Do you think the market is missing a global trend?
CG: There are so many huge disruptions that are impacting everything, ranging from absolutely terrifying to cool and exciting. Technology, innovation, it's endless, we could go on and on. Yet we are missing the biggest thing in our industry, and that's alignment. We need better ways to manage risk and extend our time frames.
Graham Hand is Managing Editor of Firstlinks. MFS International Australia is a sponsor of Firstlinks. This article is general information and does not consider the circumstances of any investor.
MFS has undertaken a two-year exercise internally, instigated by the MFS Board, to identify its own misalignments, including internal and with investors. The Board wanted to see options that ensure fund performance is consistent with how MFS views performance. The case study of its findings is attached here.