Long term investing on the horizon?
July 2, 2013
One often mentioned remark about the economic and financial turmoil since 2008 is that (among others) institutional investors need to become long term investors again. But aren’t they already?
Short versus long-term horizon is a recurring theme in public debate where banks and investors generally are positioned as being “short term” focused. For example, a decrease in duration of equity ownership is associated with increased volatility in stock markets, pressure on investment managers and corporations to produce short-term results, forcing them to make suboptimal choices, which in turn negatively affects economic growth. From this viewpoint, should the high turnover in the stock markets in the last decade be interpreted as increased short-termism? Not necessarily.
In the debate, duration of ownership (holding period) tends to be confused on the investment horizon. If an investor invests in for example equities for a longer (holding) period, then this might indicate that the investor has a long-term horizon. As an illustration, in a study for Dutch corporate governance organization Eumedion, we found that the core of the equity portfolios of five Dutch pension funds and Asset Managers consist of equities with a holding period of more than five years, some even with 10 years or more. Other investments have a captive investment horizon: investing in real estate, infrastructure or private equity per definition require a long term horizon, for the simple reason that once bought, the investor has few exit opportunities in the short term. The opposite does not hold true. If an investor holds shares for a short period, then this does not necessarily imply that the investment horizon is a short one.
A similar reasoning applies for pension funds. They generally have a long term-horizon and embed this in their decision making process with the help of Asset Liability Management. This might results in a strategic asset mix with equities, bonds and other assets that are volatile in the short term, but help earn the required risk-premia in the long term. In other words, first appearances deceive. A pension fund with a lower allocation to illiquid long-term assets than other funds cannot be earmarked as an institutional investor with a short time horizon.
Furthermore, it would be too simplistic anyhow to classify financial organization as either short-term or long term oriented. Pension funds, insurers and banks exist precisely because they intermediate between short-term and long-term horizons. In the absence of perfect capital markets, they intermediate between savers and investors, pooling and transforming the risk and duration of assets.
These academic debates have not stopped the interest in long term investing however. Sustainable investment strategies have for example embraced impact investing, where investments made into companies, organizations, and funds with the intention to generate measurable social and environmental impact alongside a financial return.
Long term investing is also viewed as a viable alternative to the retreat of the banking sector in the European Union as the main source of financing. The European Union has recently launched a Green paper consultation into financing the productive capacity of the economy. This can include energy, transport and communication infrastructures, industrial and service facilities, climate change and eco-innovation technologies, as well as education and research and development.
Green paper Financing Long Term Growth, Europese Commissie (2013)
Project on Long Term Investment and Institutional Investors, OESO (2013)
The Duration of Equity Ownership and Turnover of Dutch Institutional Investors, De Roon, Slager (2012)