Are institutional investors really long-term investors?
Editorial Note: This post originally appeared on our companion blog, Fiduciary Matters, on January 5, 2016.
The journey is as important as the destination
Institutional investors are generally seen as long-term investors. After all, defined benefit (DB) pension plans exist in order to provide benefits that last for decades; defined contribution (DC) plans are intended to last for (literally) a lifetime; and, for the ultimate in long-term, endowments and many foundations may have a mission that stretches into perpetuity.
But, in a recently-published paper, I (along with my co-authors Mike Thomas and Jim Gannon) argue that the journey to that final destination is as important as the destination itself. This means that the bulk of the individual investment decisions that are made have shorter time horizons attached to them than the ultimate time horizon of the program.
Exactly which horizons are relevant depends on whose perspective you consider. In the paper, we look separately at three categories of decisions: governing-level decisions (program oversight); managing-level decisions (day-to-day decisions by staff or portfolio managers); and execution (trading) decisions.
We also note the horizon for measuring the success of any given decision is frequently shorter than is really necessary for numbers alone to tell the whole story: a 10- or 20-year assessment period for judging the overall success of a given strategy is such a long horizon that it may have next to no practical application – and yet, it is actually a shorter time than would be required for institutional investors to know whether their strategic assumptions were realistic. Likewise, in the assessment of portfolio performance, it is often not practical to give enough time for short-term fluctuations in the numbers to even out: decisions that are based on a 5- to 7-year view may end up being assessed over 3 or 5 years.
This means that good communication between those making decisions and those monitoring the outcome of those decisions is essential. If there is not alignment, disappointment is likely to follow.