Investors with a long-term investment horizon could reap a premium of between 0.5% and 1.5% a year, according to new research – but a major shift in mindset and expanded skillsets are needed to do so.
The size of the net long-term investment premium depends on investors’ governance, asset size, mindset and investment processes, according to the Thinking Ahead Institute.
Tim Hodgson, head of the Thinking Ahead Institute, said: “In the investment world, where there are very few universal truths, it would be hubristic to claim that we and our members have proven the existence of the long-term premium.
“However, we are more certain than ever that the costs of developing the mindset and acquiring the skillsets to address long-horizon investing challenges are substantially outweighed by the return enhancements. As such we believe this is ground-breaking research because it provides sufficient evidence to answer – with a confident ‘yes’ – this perennial, billion-dollar investment question.”
Liang Yin, senior investment consultant at Willis Towers Watson and lead author of the report, said capturing the benefits of long-horizon investing would probably require “a major shift of mindset and significantly expanded skillsets by investors”.
“It is reasonable to assume the long-horizon premium exists precisely because it is so hard to capture,” he said. “In fact, 80 years ago, Keynes wrote a whole chapter on how hard long-term investing was and clearly nothing much has changed since then.”
The institute came up with the net premium from long-term investing on the basis of a case study of two hypothetical pension funds using a combination of what it identified as eight “building blocks” of long-horizon investment value.
It split these into strategies that provided return opportunities and those that led to lower long-term costs and/or mitigated losses.
The return opportunity strategies are:
- active ownership and investing in long-term oriented companies;
- liquidity provision;
- capturing mispricing effects via smart beta or factors;
- capturing an illiquidity risk premium; and
- thematic investing.
The institute attributed potential gains to the strategies, for example arguing that engagement on average generated positive abnormal returns of 2.3% in the year following the initial engagement with an investee company.
The strategies or actions that could create a drag on returns are:
- firing and replacing managers (“round-trip decisions”);
- forced selling; and
- transaction costs.
The institute again quantified the costs entailed in these strategies, for example saying that forced selling could reduce returns by 1.5% to 2% per annum.
Not all of the building blocks were independent, and some were contradictory, it said.
In the case study, the smaller pension fund focused its long-horizon efforts on avoiding costs and mistakes, while the larger pension fund, with better governance and financial resources, was able to consider all available options for capturing premia.
The institute’s next phase of research is to find out how to successfully implement a long-term investment orientation across the industry.
The Thinking Ahead Institute was set up by Willis Towers Watson.
The research can be found here.