For most fund managers there is nothing more important than adopting a long-term approach. This enables them to insulate themselves from the noise and random fluctuations of financial markets, and hopefully exploit them. Yet for many this is simply not possible. Perverse and misaligned incentives, the desire to measure everything over meaningless time periods and the ascendancy of outcomes over process mean that the long-term is nothing more than a collection of reporting months and quarters. Even when a fund manager’s express intention is to operate with a long time horizon, often they cannot because it is decided by the behaviour of other people. They don’t get to choose.
Every investment strategy or fund has a chain of involvement. This will range from the underlying clients, to the fund managers, risk teams, CIOs and even CEOs. All have differing objectives, incentives and levels of influence. Unless all parties involved are aligned, the actual investment time horizon may not be what is stated in the investment philosophy, but be set by the shortest common denominator. That is the shortest time horizon of someone involved who holds influence.
If investors have the ability to freely withdraw money from a fund and are focused on monthly performance figures, then the fact that the investment approach is designed to take a five year view becomes almost an irrelevance. Short-term numbers matter. Equally, if the CEO of a listed asset manager is worried about near term outflows then performance over the next quarter is everything. In both of these cases the power lies away from the fund manager. The client has the ability to sell their fund; the CEO has the ability to sack them.
When short-termism arises in the chain it becomes highly infectious. It affects the behaviour of everyone involved, most importantly the fund manager. Their behaviour will either consciously or subconsciously change to stave off career risk. The typical route to this is by chasing momentum. Buying what has worked recently is an easy way to please everyone in the chain, for that moment at least.
It is not that investors (whose money it is) and senior managers should not have influence or choice, but it is crucial to acknowledge the impact that this may have on the ability of a fund manager to stick with their investing disciplines. It is not easy making long-term decisions when everyone will be poring over the next set of performance figures. As soon as all involved in the chain have defaulted to a short-term view the investment outcomes become captured by randomness. Success or failure is no longer about the validity of an investment approach, it is about the toss of a coin.
How much influence other people possess in a chain relative to a fund manager will be heavily dependent on past performance. A fund manager with strong historic results will have more influence – they have pedigree and a track record. They are at little risk of outflows or redundancy so can set the terms. As performance deteriorates this changes. The manager becomes more vulnerable and the influence shifts. Without a track record to fall back on they are at the mercy of others, often with interests and incentives that are based on a horizon very different to what appears in a due diligence document.
When we consider a fund manager’s investment time horizon we often focus on how they apply their philosophy and process; with maybe some consideration as to whether their incentive package is aligned with this, But that is not sufficient. The crucial issue is whether a fund manager operates in an environment where they are able to invest with a sufficiently long time horizon. Who are the other people with potential influence over the strategy and what are their incentives? This is difficult to answer and will evolve, but is vital for understanding on what basis investment decisions are actually being made.
Investment strategies with fixed capital or fixed terms partially overcome this problem as their illiquidity forces a level of alignment; but the real benefit is for private investors. Private investors don’t have a chain of involvement; they have one time horizon and one objective – their own. They can make decisions free of competing interests and conflicted incentives. It is easy to underestimate the incredible advantage this offers in reaping the benefits of making genuinely long-term decisions.
So many professional fund managers extol the virtues of adopting a long-term approach, but how many are in a position or environment that allows their words to be validated by their actions? The structure of influence and incentives within the industry make it increasingly difficult to achieve.