Investing for Long-Term Value Creation

How can investors practically help achieve the transition to a more sustainable economy?

In "Investing for long-term value creation", Dirk Schoenmaker and Willem Schramade show how traditional investment approaches based on efficient markets and portfolio theory are inadequate for pursuing this transition.

They propose a new investment paradigm focused on long-term value creation, integrating long-term financial, social and environmental value instead of focusing on short-term financial performance.

Their main recommendations include:

• Move from Efficient Market Hypothesis to Adaptive Market Hypothesis, recognising that markets are not always efficient and new risks like environmental risks may not be fully priced in.
• Expand beyond narrow financial risk-return metrics to include social and environmental dimensions in assessing performance and integrate extra-financial value.
• Shift from factor models, indices, and shallow ESG integration as an overlay to deep integration assessing companies' transition preparedness.
• Favour active management with deep engagement over passive investing and limited engagement.
• Advocate for shorter, less complex investment chains to reduce agency problems and information loss.

This paper argues institutional investors struggle to invest for long-term value creation and perform the social function of finance due to misaligned incentives and thinking.

It outlines an alternative paradigm based on adaptive markets, which includes short investment chains, active management assessing companies' transition preparedness, concentrated portfolios, and deep engagement.

The focus on concentrated portfolios and deep engagement may be seen as impractical for large institutional investors, for which the proposed approach may be challenging due to existing institutional structures and short-term performance pressures.