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Indian lessons from Wall Street heretic

By Subir Roy
February 10, 2016 09:17 IST

Classically, the Japanese - who are not guided by short-termism - added capacity during slumps to be ready to reap their good fortune when the business cycle turned upwards again and shortages emerged, says Subir Roy.

Two major vehicles for Indians' long-term savings, Employees Provident Fund (EPF) and the National Pension System (NPS), can now invest a portion of their savers' funds in stocks. It is, therefore, vital that both their fund managers and the managements of companies in whose stocks the investment takes place have a truly long-term approach.

In between the two come a vital intermediary: Analysts who process information and offer advice, and who also ideally should have a long-term perspective. Against this, we have the widely copied US model which is hostage to the "tyranny of quarterly results."

Corporate leaders, mindful of losing investor support and fearful of the prospects of their stock prices dipping at the slightest blip in quarterly numbers, engage in short-termism at the cost of innovation and long-term growth.

A good example of short-termism is the unanimous "sell" or "reduce" recommendation given last week by brokerages for Tata Steel. Not only has it posted highly adverse results (a huge loss) for the December quarter, it is set to bring on additional capacity of over a million tonnes (mt) when there is global oversupply and undercutting by Chinese steel exporters.

The brokers' analysts can hardly be faulted, as they have a short-term perspective. But Tata Steel, which was not so long ago considered to be the world's lowest-cost steel producer, is going to produce and sell over time an additional 1.5 mt of high-quality steel. The latest adverse results and large loss are the consequence of a global slump in commodity prices (plus an ill-advised European acquisition earlier).

This downturn in steel producers' prospects has also hit ArcelorMittal, the leading global steel producer, which has asked investors for $3 billion to help it tide over the present downturn.

But, if you have, say, a 20-year perspective to pay pensioners, the scenario dramatically changes. At today's prices Tata Steel shares are a steal; nobody expects it to go under, and commodity prices do not remain down in the dumps permanently.

Classically, the Japanese - who are not guided by short-termism - added capacity during slumps to be ready to reap their good fortune when the business cycle turned upwards again and shortages emerged.

Fascinatingly, conventional wisdom is changing on Wall Street. Larry Fink, chief executive of BlackRock, considered to be the world's largest investor with a portfolio of $ 4.6 trillion, has just engaged in what has been described as "heresy" in a letter to 500 S&P chief executives and the leaders of several large European corporations.

He has advised the chief executive officers (CEOs) to resist short-termism and invest in long-term growth, as most of BlackRock's clients are saving for retirement. He is asking them to be systematic, have financial metrics for long-term growth, and link long-term compensation to it. If today investors are short-term on companies then that is because CEOs have not educated them on the importance of the long term.

As companies lay out a long-term scenario, Mr Fink says "the need diminishes for quarterly EPS (earnings per share) guidance." So he would "urge companies to move away from providing it."

Then, in a key sentence he says, "Today's culture of quarterly earnings hysteria is totally contrary to the long-term approach we need." What CEOs should do is demonstrate "progress against their strategic plans," rather than "one penny deviation from their EPS targets or analysts' consensus estimates" (emphasis mine).

As if this is not heretical enough, in his concluding paragraphs Mr Fink seems to be wanting to cross over to the side of "Occupy Wall Street" protesters. Generating long-term returns requires a sharper focus on the "environmental and social factors facing companies today." This is part of his sense of the historical implication of the Paris climate accord. He is clear that, over the long term, it is the environmental, social and governance issues (ESG) which will matter. Good ESG play is "often a signal of corporate excellence."

How relevant is all this for India? Mr Fink notes that there is "massive global inequality." Then he adds, "investment in infrastructure - and all its benefits, including job creation - is also critical to growth in most emerging markets…At a time when there is so much of uncertainty in the capital markets…it is critical that investors in particular hear a forward-looking vision about your own company's prospects and the public policy you need to achieve consistent, sustainable growth."

Thus, the world's biggest investor is speaking the language of "conscious capitalism" and is not too far away from the goals of social entrepreneurship which looks for a return that is sustainable and enabling public policy that promotes investment in infrastructure and reduces inequality across the globe.

Thankfully for India, issuing quarterly guidance along with earnings statements is rare. The one sector that took to it was information technology and when its key practitioner, Infosys, stopped issuing quarterly EPS guidance in 2012 it was roundly pilloried by brokers' analysts. Now, most notably, Cognizant sticks to issuing guidance with gusto. That makes it almost a minority of one.

Photograph: Thomas Lohnes/Getty Images

Subir Roy
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