We see it every week in soccer, baseball or football: a big win is celebrated like the triumph of a decade; a defeat is immediately a call for action against the coach.
Every quarterly earnings release moves the market capitalization of corporations by billions, either euphorically up or despairingly southwards. As a global society, we are heavily biased towards short-term results, and easily overreact to daily news. Ultimately, short-term thinking and unsustainable practices, policies and behaviors caused the global financial crisis. This includes opportunistic government policies as well as a lack of international regulation and a failure to proactively identify risks. Additionally, complex and intransparent financial products with short-term incentive systems were certainly among the most prominent failures of capital market participants.
The rules of capitalism, especially the free flow of capital independent of national borders, have been blamed for the financial meltdown. But is it really true that properly functioning capital markets drive short-term thinking? Do the capital market principles fundamentally contradict sustainability, defined as creating a business for the long term? Indeed, many investors are only interested in quick gains, which can create unacceptable volatility and inhibit sustainable developments and gains for other market participants. However, short-term investing can play an important role in supporting the marketplace and have a number of positive impacts.
For example, hedge funds are often instrumental in providing liquidity to the market and helping struggling companies. And many of the IPOs around the world would not be possible – or would only happen at undervalued prices – if short-term investors did not buy large amounts of IPO shares at public offerings. Furthermore, despite the criticism that has been leveled at the mechanics of capital markets, they are, in fact, key drivers – if not a prerequisite – for sustainable economic growth.
We need to align short-term thinking and long-term solutions
Functioning financial andcapital markets are essential for economic recovery. They are necessary for further economic growth in the developed world and can provide a basis for addressing many societal problems in addition to supporting the continuous progress of the developing world.
And I firmly believe that long-term investing is a requirement for functioning capital markets. Therefore, we need to align short-term thinking and long-term solutions. In addition to flexible and liquid capital markets, it is essential to support (via incentives and other methods) long-term capital in order to cope with the many challenges ahead. From an institutional standpoint, organizations must be required to provide reasonable employee compensation schemes that offer a balanced proportion of variable incentives and deferrals. Regulators and policy-makers, however, must balance these goals carefully in the wake of the financial crisis, being careful not to overstep their financial limits.
International regulations must also be re-examined to determine their potential negative impact on long-term investment strategies. For example, within Europe, Solvency II clearly weakens the long-term investment strategy within the pension fund industry and insurance businesses. Solvency II requires a stronger capital allocation should asset prices fall, thus hindering the opportunity to buy in times of crisis and reinforcing a reactionary, short-term approach.
Taking action to avoid a crisis
From a broader regulatory and policy standpoint, international governments and agencies need to act in concert on a global scale. The financial crisis has clearly demonstrated that regional laws are inappropriate for coping with the globalization of today’s capital markets.
In addition to the governmental and institutional changes, individual investors also need to alter their approach. Today, the individual is responsible for his or her needs. With government safety nets growing ever weaker in Europe and elsewhere, it is increasingly individuals, rather than institutions, who are required to make complex, life-altering decisions about how much to save and how to make those savings last. Without action, an international crisis is surely in the making.
The question is, how can asset managers, governments, financial advisors and institutions help investors take the most prudent strategy for their retirement savings and support efforts to invest with a view to the future? The answer may indeed rest with understanding how and why investors make decisions. Initiatives like the Behavioral Finance Center provide invaluable insight into the motivations and needs of investors, using academic research on topics ranging from risk aversion to cognitive impairment. By considering the behavior of retirees, plan advisors and policy-makers can better address the needs of this client segment and tailor solutions to help them achieve a secure retirement.
No examination of the future of long-term investment would be complete without mentioning that asset managers must also undergo a fundamental shift in the way they conduct business. Our business is not about pushing specific products; it is about partnering with our institutional clients and providing long-term solutions.
At Allianz Global Investors, we have constructed our value proposition around this point: we know clients want more than performance, which is ultimately the most obvious goal for an active investment manager. Clients, however, also value us because we listen to them and understand their needs. At the same time, it is critical that our clients understand how our investment philosophy and processes capture alpha (outperformance).
Investors – especially those with a long-term view – also want to know how and why past excellence can be sustained. Specifically, they look for changes in investment philosophy, process and personnel. Clients value trust, and that trust must be earned in order to build solid relationships between asset management and investors. It is this kind of partnership that is able to overcome the potential conflict of interest between achieving short-term performance of asset managers and the long-term objective of institutional investors.