A premium for long-horizon investing has been quantified for the first time. A study from the Thinking Ahead Institute’s long-horizon investing working group puts a figure on the value add of eight building blocks of long-horizon investing and highlights the importance of governance in harvesting that premium.
The group’s study report, The search for a long-term premium, states that there is a net premium available by accessing return opportunities and limiting the drag on returns. The five strategies that provide opportunities for long-horizon investors are active ownership and investing in long-term oriented companies, liquidity provision, capturing systematic mispricing, illiquidity premium and thematic investing. The three that lead to lower costs are avoiding buying high and selling low, avoiding forced sales, and lowering transaction costs.
The report argues that depending on an investor’s size and governance arrangements, a premium of between 0.5 per cent and 1.5 per cent a year is available via these building blocks.
Tim Hodgson, head of the Thinking Ahead Group 2.0 at Willis Towers Watson and co-author of the report, says the premium exists but is hard to achieve.
“The key reason investors are not harvesting the long-term premium is because their governance is not up to it,” Hodgson says. “It requires a change in mindset and skill set.”
Worth the costs
For most investors, there will be some incremental governance costs required to implement these eight strategies. The group identified these costs as 15 basis points for a smaller asset owner and about 8 basis points for larger owners. However, the return gain for these actions is larger – estimated at 65 basis points for smaller asset owners and 161 basis points for larger owners.
“Asset owners will need to spend money, but it’s more than worth it,” Hodgson says. “This paper needs to survive public scrutiny so we have been cautious in our assumptions. If it becomes generally accepted there’s a long-term premium, then any investor with a fiduciary duty will have to consider it.”
The paper outlines the actions and costs of two funds – a small fund and a large one – in harvesting the eight building blocks of long-term value creation.
The smaller fund’s focus was on avoiding costs and mistakes; for example, by reducing manager turnover, avoiding chasing performance and forced sales, and moving some of the passive exposure to smart beta.
The example of the larger fund shows the advantage of having the governance and financial resources to consider all available options for capturing the premiums, including active ownership, investments in thematic exposures and setting aside cash to exploit forced selling.
The paper raises a number of questions regarding how investors would access the building blocks of value creation, and the working group will release a second paper outlining what investors require to implement them. This second paper will also include an examination of the beliefs needed to adopt this strategy.
Hodgson says some of the negatives that have a drag on returns, such as high turnover of managers and excessive costs, are explained in part by behavioural aspects.
The group deliberately does not define what “long horizon” or “long term” is, but it does attempt to say what it is not.
“It’s not having a minimum holding period, it’s not buy and hold; you’re allowed to sell,” Hodgson explains. “My personal definition is a long ‘look-up’ window, so for any decision an investor is making today, they should ask, ‘How will this pan out in 10 years?’ ”
The paper can be accessed here