“In the long-run we are all dead”, John Maynard Keynes, renowned economist, 1883–1946.
For many, “long-term” has remained an abstract, elusive, and rather fluid concept with no clear and universal definition. No wonder then that it occasionally gets conveniently redefined to suit a particular narrative or argument. Investment textbooks have also not helped that much in clearing the ambiguity.
Of course, on all matters definitions, there is one vault of knowledge that we all rush to when not sure, or worse still, when completely ignorant – the dictionary. Many have been “clever” enough to do that and went searching for the definition of “long-term” in say the Oxford dictionary, and they would have gotten it. The definition of “long-term”, according to the Oxford dictionary, is, “over a long period of time.” Rather very specific, isn’t it? Well, with such a definition, or lack of one, we are back to ourselves, and we are on our own again. Googling would not be an option here – it’s too serious a matter for that.
Not Just a Matter of Investment Horizon
Two things make this conversation vitally important at this point in time. First, the advent, proliferation, and projected growth and dominance of alternative investments demands that trustees are clear on what being long-term investors means. Stepping out of the highly liquid listed investments space into the highly illiquid alternative space, with all its lock-in periods, and an absence of secondary markets, calls for a much deeper matching, by term, of a pension fund’s investments to its cash outflow commitments. In the fast-approaching era of alternatives – private equity, private debt, private infrastructure, and others, the stakes are just so much high and the need for a robust due diligence process is just so much more heightened. Understanding the investment horizon over which the fund can comfortably invest becomes an all-critical requirement.
Secondly, and more importantly, long term investing is not just a matter of investment horizon description. It goes much deeper than that. There are deep socio-economic expectations with which the responsibility comes. Long term investors, pension funds included, play a critical role in growing economies and developing capital markets. This is even more pronouncedly so when they allocate to alternative investments. The prescribed assets status regime has significantly elevated the importance of alternatives in pension funds’ asset allocation discussions.
Long-Term Commitment in a Short-Term World
Adopting and embracing a genuine long-term investing mindset requires both a cultural shift as well as a recalibration of purpose. It puts a stop to the fascination and obsession with quarterly investment reports that some pension funds display. It redirects the trustees’ attention to the long-term investment metrics that really matter, the ones that speak to the real objectives that are front and central to the core existence of the fund – ensuring that members retire with enough income to live on. It is the adoption of a new philosophy and approach to managing members’ retirement savings.
No doubt, a proper definition of what “long-term” is for pension funds needs to be proffered if trustees, and practitioners alike, are to deliver consistently and successfully on what is expected of them by members. While such a definition might not really be in line with what some theoretical models might say, it is a much-required definition for the creation of a common reference for the management of pension funds investments. It is a definition required by necessity.
But maybe, let us start by getting other investment horizons out of the way. So, there is the short term, the medium term, and of course the long term. While many generally think of the short term as anything under a year, our view is that in the pension fund space anything under three years would qualify to be called a short-term investment. This is especially so if we bring in another additional definition – the immediate term, and that would be any investment of under a year. The ideal investment strategies for these periods would definitely have many common and overlapping features but would certainly not necessarily be the same. Fund credits of a member retiring in three months’ time can frankly not be invested in the same way as the fund credits of a member only retiring in two-and-a-half years’ time.
The medium term is the easiest one to define – it is anything that is neither short-term nor long-term.
It is critical that we are clear here that we are talking about pension funds being called long-term investors and what that label means, and how it demands of them to behave. This is certainly not about the frequency with which they evaluate the performance of their investments.
The Magical 21-Year Period
To attend to the question of what it entails to be called long-term investors, we need to first acknowledge that pension funds investments are not made in a vacuum. Instead, they are a part of the ecosystem of a mosaic of cogs, wheels, and gears that keep societies and economies going – and through which mankind continues to evolve.
Something special about the 21-year period.
For starters, it is roughly equivalent to about three economic cycles. And in three economic cycles, most major socio-economic trends would have fully shaped up, played out, plateaued, and faded away. Anyone invested over three economic cycles can sure be certain that they have been able to capture and reap some of the most benefits that one such an economy can offer. They would have had their investments across a number of different economic cycles. With investments, it is all about time in the market and an investment that spans across a number of economic cycles will most likely benefit the most.
In the era of the rise of alternatives, trustees need to assess the appropriateness of certain projects within the context of their investment horizon. Taking the view that they are a 21-year-long investor helps inform their decisions on the type of illiquid alternative investments they can be exposed to. For instance, an infrastructural project like building a power station can take anything up to 20 years before it starts generating cash-flows. Knowing that, and in the backdrop of a clear view of their investment horizon, helps guide trustees on how much of an allocation, if any, they can make to such a long-term and illiquid investment.
Private equity investments, on the other hand, though as illiquid, are generally of a much shorter fixed term – around 10 years on average. With a 21-year investment horizon, a pension fund can effectively invest into two private equity funds, one after the other – thus helping with spreading the risks.
Recent studies have found that, while the average lifespan of companies was 61 years back in the late 1950s, today it is around 21 years. So, consistent with the philosophy that even in the listed space, long-term investors should think of themselves as buying companies and not shares, investing with an investment horizon that matches the average lifespan of the average company would not be considered a bad strategy.
Thematic investing, which is investing in powerful global long-term trends transforming the way we live and work, is becoming more and more popular lately. These are themes at the intersection where human ingenuity meets socio-cultural shifts. While such themes do not share a common cycle from innovation to growth, to maturity, they are generally considered long term trends of about two decades long. So, pension funds looking into investing according to, and profiting from, any particular theme, would be glad to realise that, generally, such investment themes are aligned with their ideal investment horizons.
Where government bonds generally come with tenures of 10, 20, and 30 years – with an average of about 20 years, assuming a 21-year-term investor status does not sound like a wrong thing to do as well.
Demographics Support It Too
Some renowned investment gurus have argued that the quarter that really matters in investment management is not the quarter of a year, but the quarter of a century over which one remains invested. 21 years seems reasonably close to that.
But here is where it gets interesting. 21 years is about half of an average member’s working life – think of it as the half-way mark where members can pause to take a serious look at and check if they are on track to achieving their dream lifestyle in retirement. At the halfway mark, such an analysis would neither be extremely too pre-mature nor way too late.
The average membership age for most pension funds is around 42 years. With a retirement age of about 63 years, these pension funds have an average investment horizon of about 21 years. Of course, the cohort of members nearing retirement would require a specific strategy of their own. For the rest though, investing with a 21-year investment horizon would not be considered unsound.
While our life expectancy at birth is around 63 years, equivalent to about three 21-year periods, there is an argument to be made that those who make it to age 63, and are still working, are likely to live for another 21 years before they die. That too informs the custodians of pensioners’ retirement savings of the time horizon over which they can expect to be paying pensions, requiring that they invest the reserves backing the pensions accordingly.
On average, in 21 years a new generation of people, with totally new tastes, preferences, and behaviours emerges. From Boomers to Gen Xs, to Millennials, and now to Gen Zs, each of these cohorts has brought with it a markedly different and new perspective to life. If retirement fund members are to be looked at through the lense of their generational cohort, it would make sense to invest according to an investment horizon that matches the average span of the individual cohorts too.
While there remains no exact science in defining what “long-term” is, here we proffered a reference point based on which trustees can evaluate the appropriateness of the investments that get offered to them. Core to this evaluation is the need to match funds’ investments to their cash outflow obligations by nature, term, currency, and degree of variability. We focused on the “term” element here. The issue of matching assets and liabilities is a key focus area of the field of asset-liability modelling. Trustees, as they review their investment strategies, need to work with the funds’ actuaries to guide them on the terms, among other parameters, of their funds’ liabilities and hence the appropriate investment horizons.
Our monthly publication is aimed at inviting conversations from like-minded individuals with a view to engaging in forward-thinking-led discussions on how we can collectively improve the state of our industry.