Ever notice the number of institutional investors that will tell you they’re investing for the long term? It’s pretty much all of them, right? It’s a bit like how many asset managers you meet that are ‘top-quartile’ – or how many parents have kids that are above average. It’s just not possible. I’m sorry, moms and dads, there’s a pretty good chance – 50% in fact – that your kids are below average. And when it comes to institutional investors being long-term, there’s a big difference between rhetoric and reality.
For example, we know, generically, that the holding periods on the NYSE have decreased from more than five years in the 1980s to less than five months today. In other words, the rapid growth in the number of long-term investors (e.g., pensions, sovereigns, endowments) over the past 30 years has, in fact, coincided with a dramatic decrease in the time-horizon of all investors. It’s really quite odd when you think about it. So what gives? With so many long-term investors in the world, why aren’t we seeing more long-term investing?
The short answer (which is all you can ask for in a blog post): It’s really hard to be a long-term investor. In fact, it’s beyond the control of most investors because it requires much more than the control and motivation of any one person. Indeed, resolving the problem of short-termism requires a holistic approach to the fund that considers four key factors: fund endowments, organizational design, institutional governance, and management. And you really can’t disentangle one from the other. For example, consider the following characteristics/practices of good long-term investors; they should:
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have independence from external influence;
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compensate staff and service-providers in a manner that aligns interests;
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understand what drives external managers to shorten their time horizons and change their allocation decisions accordingly;
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be able to effectively manage assets in-house;
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have discipline thanks to a clear process;
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have a tolerance for volatility;
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not be focused on exits or liquidity;
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not benchmark against investors that aren’t long term;
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be sensitive to all future liquidity constraints;
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have a contrarian disposition;
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not depend on future capital infusions to execute a strategy; and
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think about risks that will impact the world in the distant future (resource scarcity, demographic ageing, and climate change).
Each and every one of these factors incorporates some aspect of a fund’s endowments (i.e., the fund’s inherent qualities); design (i.e., how the fund was originally structured and positioned); governance (how the fund’s sponsor and Board set out its protocols and processes); and management (how the talent actually run the fund). As an exercise, go back through each of the bullets with these four factors in mind; I think you’ll be surprised at the frequency with which each one appears.
This should give you some understanding of the scope of the challenge. I’d wager that aligning endowment, design, governance and management in a way that facilitates long-term investing would require some level of agreement among four groups of individuals. And that means that actually being a long-term investor is hard...very hard indeed.
But the thing is...it’s worth it. If you can manage to get the above principles right and invest for the long-term, you can take on additional risks with bigger potential rewards (e.g., illiquidity), while avoiding transaction costs and forced sales (among other things). You also provide confidence for your portfolio companies and asset managers to take a long-term approach to their business, which is also good for you. And, best of all, when you focus on the long term, you distance yourself from the competition. Here’s David Denison of the CPPIB:
“Our view is that the vast majority of the considerable intellectual capital devoted to the investment industry is actually focused on a 0 - 24 month time horizon. Rather than us joining this hyper competitive universe, we quite simply believe there is a better opportunity for us to capture value added returns by focusing on the long horizon end of the spectrum where there are far fewer participants and far less competition...”
That sounds imminently sensible to me. And that’s why, my friends, everyone and their dog is trying to understand how they too can become a long-term investor.