Report: Long-Term Investors Have an Edge

(November 30, 2011) — Long-term investors have an edge, a newly released paper asserts. 

The report — titled “Investing for the Long Run” by Andrew Ang, a professor at Columbia Business School, and Knut N. Kjae, current President at GCapm and former CEO of Norges Bank — asserts that long-term investors can ride out short‐term fluctuations in risk premiums and profit from periods of elevated risk aversions and short‐term misplacing. “…They can pursue illiquid investment opportunities. The turmoil we have seen in the capital markets over the last decade has increased the competitive advantage of a long investment horizon. Unfortunately, the two biggest mistakes of long‐horizon investors—procyclical investments and misalignments between asset owners and managers—negate the long‐horizon advantage, the authors state, noting that long‐horizon investors should harvest many sources of factor risk premiums, be actively contrarian, and align all stakeholders so that long‐horizon strategies can be successfully implemented.” 

The report continues: “Illiquid assets can, but do not necessarily, play a role for long‐horizon investors, but investors should demand high premiums to compensate for bearing illiquidity risk and agency issues.”

According to the research, avoiding procyclicality requires redefining the concept of risk away from just volatility, as low volatility often coincides with low expected risk premiums, which are a more relevant concept of risk for the long‐run investor who can withstand short‐term fluctuations. “Investors should practice factor investing and build robust factor portfolios. Long‐term investors can harvest many sources of factor risk premiums. They should go beyond asset classes and use the underlying factor risk premium drivers as the basis for portfolio construction. Doing this requires creating close alignment between asset owners and managers.”  

The report follows a March study by the World Economic Forum (WEF) about the future of long-term investing. In the report headed by 19 major pension and private investment funds, the WEF warned earlier this year that policy and investor changes are instrumental in driving the growth of long-term investments.

“This report is directly helpful to institutional investors because it will highlight the challenges inherent to long-term investing and makes recommendations how to address them,” Max von Bismarck, director and head of investors of the WEF and co-author of the report, told aiCIO. “We’re trying to understand long-term investors in today’s market, how they differ in their abilities to execute long-term strategies, and what constrains them,” he said, adding that while the need for long-term capital is rising, the ability to make long-term investments is dwindling. According to von Bismarck, the financial crisis has spurred questions about whether short-term objectives of institutional investors have outweighed long-term growth and value creation. “We’ve seen shorter and shorter holding periods as investors face increasing long-term constraints.”

According to von Bismarck, long-term investors are crucial for the global economy, acting as counter-cyclical forces in markets during times of high volatility, solving decaying infrastructure problems around the world, and helping to transition effectively from a high carbon to low carbon economy.