By J Chandler CourtesyIDN-InDepth NewsReport
TORONTO (IDN) - Huge long-term investments are required for developing the global infrastructure and reducing CO2 emissions that are a menace to human beings and nature. A new report estimates that every year some 3 trillion U.S. dollar are needed for improvement and expansion of infrastructure. In addition, an average of 500 billion dollar is required each year by 2020 for investing in clean energy.
However, governments, stricken by the financial crisis, are not in a position to meet such gigantic needs, asserts 'The Future of Long-term Investing', a report prepared by the World Economic Forum, emphasising the "important role that only long-term investors can potentially play in stabilizing the markets at a time of distress and enabling corporations to focus on long-term strategic decisions".
At the same time, the ability to make long-term investments is diminishing, says the report published on March 29, 2011. It finds that long-term investors as a whole have been able to allocate only 25 percent of their capital to long-term investments, and this figure is likely to fall as a result of the economic crisis and increasing regulation.
Long-term investing is defined as investing with the expectation of holding an asset for an indefinite period of time by an investor with the capability to do so. Investors engaged in long-term investing are less concerned about interim changes in asset prices, and instead are focused on long-term income growth and/or long-term capital appreciation both in their initial evaluation and continued interaction with their investments.
Long-term investing is not appropriate for all investors, says the report. However, when executed correctly by the right investor, it can benefit three key constituencies:
-- Investors who potentially enjoy better returns through accessing risk premia (for example,. for assuming liquidity risk) and avoiding the costs sometimes associated with short-term strategies (e.g. transaction costs, forced sales, short-term behavioural investor biases)
-- Companies who can more easily pursue strategic initiatives with long-term potential and large up-front costs
-- Society which can gain from the stabilization of financial markets by countercyclical investors and the direction of capital towards projects where returns are generated over longer time horizons.
INTERNAL CHALLENGES
The report argues that there are considerable internal challenges that must be overcome when making long-term investments. In particular, many institutions have material short-term financial obligations that must be funded with short-term investments.
"Furthermore," says the report, "investors must overcome organizational conservatism and principal-agency considerations to make long-term decisions. These additional internal constraints make funding difficult to find for projects with short-term losses but potentially significant long-term gains."
"The report highlights the significant barriers that must be overcome in order to execute an effective long-term investing strategy and the broader economic implications of those constraints," says Tony Tan Keng-Yam, Deputy Chairman and Executive Director of the Government of Singapore Investment Corporation, and chair of the steering committee for the World Economic Forum's Long-term Investing project.
In addition to internal challenges, there are significant regulatory pressures that also impact the ability to make long-term investments. For instance, strict capital requirements can limit the ability to make long-term investments and promoting pro-cyclical behaviour on the part of the long-term investors.
Angelien Kemna, Chief Investment Officer of the Dutch APG All Pensions Group, says: "Having to account for mark-to-market price changes for assets that we do not intend to sell for many decades makes it harder for us to hold these assets through a market downturn."
Increasing constraints can prove challenging for the broader economic recovery, as there are significant societal benefits that can arise from long-term investing, especially in a post-crisis environment.
Max von Bismarck, Director and Head of Investors Industries at the World Economic Forum, USA, notes: "The world is looking to long-term investors to help fund projects such as infrastructure that have historically been funded by governments. However, these investors are increasingly unable to meet these needs."
In addition to long-term projects, corporations with long-term shareholders are more likely to make significant investments in research and development (R&D) and other long-term initiatives, investments that enable economic growth.
Policy-makers therefore face a dilemma when regulating long-term investors. Julia Hobart, partner at Oliver Wyman and senior adviser to the project, says: "Policy-makers must integrate their dual goals of ensuring solvency and stability of individual institutions with promoting broader global economic growth. When these issues are considered separately, significant unintended effects can arise."
The report concludes with six recommendations for long-term investors, regulators and policy-makers that are intended to ease the constraints on long-term investing and increase the benefits that flow from it:
-- Policy-makers should consider the unintended impact of regulatory decisions on investor ability to make long-term investments
-- Policy-makers should mitigate the impact of capital protectionism on long-term investors
-- Long-term investors should develop performance measurement systems that balance fostering a long-term perspective with short-term accountability
-- Long-term investors should implement compensation systems that better align stakeholders with the long-term mandate
-- Long-term investors should promote among stakeholders a better understanding of the implications of a long-term investing strategy
-- More engaged ownership of public companies by shareholders should be encouraged by policy-makers and long-term investors
The findings and recommendations of the report were discussed by leading investors, corporate executives, policy-makers, regulators and academics at the World Economic Forum Annual Meeting in January 2011 last January in Davos, Switzerland.
