Institutional investors could boost annual returns by up to 1.5 per cent through long-term investment strategies, according to a new meta-study.
The Willis Towers Watson-backed ‘Thinking Ahead Institute’ report found investors focused on the long-term could realistically expect to reap “meaningful” benefits by capturing opportunities and reducing costs (or mitigating losses).
“We propose that with reasonable assumptions a smaller asset owner focusing its long-horizon efforts on avoiding costs and mistakes can see an increase in investment returns of about 0.5% a year,” the study says. “A larger fund with the governance and financial resources to consider all available options for capturing premia could see a net uplift to returns of around 1.5% a year.”
The findings were based on “13 empirical studies and two investment models that quantified a number of long-term premia”.
Authored by Tim Hodgson, Liang Yin, Jeremy Spira, ‘The search for a long-term premium’ report identifies eight “building blocks” that underpin long-horizon investing benefits – split between opportunities and cost reduction/risk mitigation strategies.
The long-term investment opportunities cover:
- Active ownership and investing in long-term oriented companies;
- Liquidity provision;
- Capturing systematic mispricing;
- Illiquidity premium; and,
- Thematic investing.
Long-term investors could also rein in costs and/or scale back losses by:
- Avoiding buying high and selling low;
- Avoiding forced sales; and,
- Lower transaction costs.
In total, the study found the eight ‘building blocks’ added about 10 per cent to annual returns. However, the report says the summing up the parts is “simply illusionary, because the building blocks are not completely independent of each other”.
Based on a more conservative implementation modeling, the study says a small fund ($1 billion under management) could expect to squeeze out an extra 0.65 per cent in returns less the 0.15 per cent increase in governance costs associated with adopting a long-term approach.
Meanwhile, larger funds ($100 billion) would be more able to capture long-term investment opportunities – of 1.61 per cent per year, according to the study – for a lower proportional increase in annual governance costs (0.08 per cent).
“The costs of developing the mindset and acquiring the skillsets to address long-horizon investing challenges are substantially outweighed by the return enhancements,” the report says.
Furthermore, the Thinking Ahead Institute paper argues a large-scale shift to longer-term investing could be “beneficial for the wider economy and financial ecosystem”.
“By focusing on long-term value drivers, investors can encourage longer-term thinking in both their target companies and across the corporate universe,” the report says. “This has the potential to give rise to a virtuous circle for investors and companies.”
The Thinking Ahead Institute plans a series of follow-up reports on long-term investing to investigate underlying principles and implementation options.