Notes

Taking the long view on investing: The ‘why’ and ‘how’


In a fundamental sense, the task of official and sovereign investors is to select appropriate portfolios that are expected to achieve objectives, while controlling risks of not succeeding. This exercise becomes harder as constraints are added. For example, some institutions have caps on allocation to certain asset classes or exposure to certain asset manager or country; pre-defined rebalancing frequency or bands; or minimum liquidity requirements. Not an easy task to say the least.

However, one advantage official institutions have is that the asset allocation exercise carries over on a number of days, months and years. In this piece, we will discuss portfolio management over long horizons. We will show WHY institutions should take advantage of this edge and HOW they can go about implementing long term oriented investments

Our goal is to answer the following questions:
1) Why is long term investing different than short them?

2) What advantages a long term investor has over short term investors?
There are essentially three key advantages held by long-term investors. These include:
i) the capacity to adopt positions where payoff timing is uncertain
ii) hold positions through difficult times (have discretion over trading)
iii) the ability to exploit opportunities generated by the actions of short-term investors (which are forced to trade, leading to mispricing);
iv) latitude to invest in unlisted and/or illiquid assets
These advantages provide access to a broader investment opportunity set than available to short-term investors.

3) Are there conditions in which it really does not matter if the firm has a long term or short term investment policy?
4) Are institution investors harvesting their ability to invest for the long run?
5) What are some of the challenges associated with long term investing?

The gravest danger relates to errors in forming long-term expectations, in particular mis-estimating long-term value or expected returns. Long-term investments typically involve a high level of commitment due to their long duration and sometimes illiquid nature. Getting expectations wrong may lead to being lodged in an underperforming asset for an extended period before the error is discovered, after which unwinding the position may prove tortuous and costly.

Further, long-term investors face a number of points of vulnerability that are rooted in organizational, agency and behavioural influences. While long-term investments may attract broad support at the outset, commitment to positions can be sorely tested on many levels if success does not become evident within a certain period of time. Long-term investing programs can also be hampered by issues of alignment with employees or external managers who may be operating on shorter horizons.

6) What are current opportunities?