It used to be that “institutional” investors were the paragons of long-term investing. The entities included in that title ranged from pension funds (defined benefit), to custodians and money managers of 401(k) plans (defined contribution), to insurance companies and others. In past decades, the actuarial requirements for payouts from these entities for beneficiaries were such that the institutions took a longer-term view of their investment returns, and “long-term” meant the decades to come.
Well, those decades are here now, as the population demographic becomes more heavily tilted towards the upper end of the average age span. And the institutional investors whose investment decisions are ruled by demographics must achieve high relative returns over much shorter periods, while maintaining a lower risk profile since the funds must be more liquid than they were in the past. That’s a tough trio to achieve: high returns, near-term, low risk. Wouldn’t we all love to find that investment trifecta? If we were students of history (and most people are not) we’d know that these three elements are governed by the same law that rules three other qualities: good, fast and cheap. You only get two. So what are the institutional investors to do?
Many thought they found the holy trinity of investing in triple-A rated derivatives. The problem there is that the rating agencies aren’t really that good at identifying the true risk. They may not even care all that much about it. If you want to get a glimpse of the Wizard behind the curtain of derivative investing, I’d highly recommend a book by Frank Partnoy, professor of law at the University of San Diego. It’s called “Fiasco”, written a few years ago, and it’s about the hidden world of the financial markets. Mr. Partnoy followed that critically acclaimed book with “Infectious Greed”, which tracks the story further along its trajectory. I fully expect a third book, to chronicle the result of more than two decades of fundamental shifts in the capital markets, and nearly a decade of double-deficits. It will probably be called “Where the Chickens Roosted”.
I was talking to a high-level executive from one of the large municipal pension funds a few months ago, who had just described his fund’s perspective as “long-term”. I asked what that meant in years. He said, “Three to five.” I suppose that, compared to day-trading and programmed stock transactions, it is indeed long-term. When investors are checking equity market movements by the minute, three to five years sounds like eternity. I asked myself, “If our biggest investing institutions consider five years their farthest horizon, who is paying attention to the investments that will be critical for time periods far beyond that? Who’s looking at ten, twenty or fifty years into the future?”
Some Japanese companies have 100 year planning horizons. The Hopi of northern Arizona plan seven generations ahead. The Chinese are embarked upon a planned era of social and economic change that spans many decades. It won’t be easy or bump-free, but they’re using a telescope to do their thinking, not a microscope. We could take a lesson from these examples. But we need to be able to think selflessly to do so. Any event envisioned far enough into the future that it transcends our own demise must therefore not be concerned with us.
I was at a cocktail party several years ago, attended by many of the most successful and influential business leaders in San Diego county. Not sure how I got invited. A group of us were talking and someone asked me about my investment company’s philosophy of investing. When I told them we were looking at investments whose returns weren’t anticipated in less than ten years, one person in the group was confused.
“How old are you Stan…?” he asked.
I replied, “Fifty-four. Why?”
He didn’t understand our strategy, saying, “Many of your investments won’t yield returns within the time frame that you can personally use the liquid funds.”
I tried to explain, “Look, it’s not about us. It’s about our kids and our grandkids.”
From the quizzical look on his face, I can only conclude that he didn’t have either.