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Profiting from longer-term thinking

Strategies to ride out short-term pressures
How to combat stock market inefficiencies

by Darrell Delamaide, New York

Thu 13 Dec 2012

‘Short-termism’ and the pressure it puts on market participants at all levels can be the nemesis of long-term investors like sovereign wealth funds (SWFs). But these pressures also represent a good reason why they were set up, since they have the size and protection to ride out short-term fluctuations and benefit from long-term value creation.

The volatility produced by short-term actors challenges the investor taking a long view to balance between momentum and value, according to participants at a conference last week at Columbia University in New York. Speakers and panellists proposed solutions to this quandary ranging from the introduction of ‘loyalty shares’ for rewarding long-term investors to a better understanding of the time lags involved in assets shaking off irrational market behaviour.

The conference, ‘Long-term investing: An optimal strategy in short-term oriented markets,’ was organised by the Committee on Global Thought at Columbia and the Sovereign Wealth Fund Research Initiative (SWFRI). Speakers included academics like Nobel Prize-winner Joseph Stiglitz as well as practitioners.

‘Extrapolation – that past trends will continue – is the main inefficiency in the stock market and is responsible for momentum trading,’ Jeremy Grantham, chief strategist at the asset manager GMO in Boston. ‘Everything will return to fair value – it’s the timing that’s uncertain.’ Grantham quoted John Maynard Keynes’ dictum that markets can stay irrational longer than a client can stay solvent, but said long-term investors like SWFs were able to prove Keynes wrong.

The stock market may actually be less volatile than it seems, David Laibson of Harvard University said. Equities almost invariably revert to the mean, but it can take much longer than many forecasters expect: more likely 10 years rather than the five year maximum put forward by many forecasters. As a result, many investors ‘radically misperceive the riskiness of volatility,’ Laibson said, by a factor of nine – an argument for giving greater weight to equities.

Some long-term investors have come to the same conclusion, according to SWF executives. Norway’s sovereign wealth fund shifted the equities portion of its portfolio to 60% from 40% in the four years after the onset of the 2007-08 financial crisis, Pål Haugerud of the Norwegian Finance Ministry said, enabling them to recoup some losses engendered by the crisis.

Mats Andersson, chief executive of the Fourth Swedish National Pension Fund (AP4), said his fund is required by law to maintain 60% in equities. The New Zealand Superannuation Fund has undertaken a ‘strategic tilting’ in favour of equities, chief executive Adrian Orr said, lowering its allocation to bonds.

Some speakers, however, saw the need as well for institutional changes to combat the pressures. Patrick Bolton of Columbia University and Frédéric Samama of SWFRI presented a case for creating ‘loyalty shares,’ perhaps in the form of warrants granted to existing shareholders that could be exercised after three years for a period of three years. ‘This is a solution to how to reward long-term investors,’ Bolton said.

The effect of a corporate culture of sustainability on corporate behaviour and performance outcomes was the subject of a presentation by Robert Eccles of Harvard Business School. In a matched sample of 180 companies, Eccles and his co-researchers found that ‘high sustainability’ companies significantly outperform their ‘low sustainability’ counterparts over the long term in both stock market and accounting performance.

In their panel discussion, the practitioners affirmed the relevance of this correlation in practice. AP4’s Andersson said he doesn’t believe in ‘positive investment’ for its own sake, but because the return is better. Likewise, he said, his strategy is focused on individuals. ‘It’s rare to find a good chairman running a bad company,’ he said.

In the end, some participants said, long-term investing is not that different from short-term investing, except for taking the long view. ‘It’s a fallacy to think of long-term investing as ‘buy and hold,’’ said Andrew Ang of Columbia Business School. ‘It means constantly trading.’

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