Scepticism about the 10-year investment mandate

Most institutions are not 'long-term investors' and shouldn't pretend they are when figuring out how to appoint and review external fund managers, says Tim Gardner, Mercer Investment Consulting's London-based global investment consulting practice leader at a recent seminar organized by the firm in Hong Kong.

What is more important for institutions seeking consistent returns is a good governance structure and an acknowledgement that human nature as well as rational theory plays a role in how organizations manage their assets.

The Nasdaq crash ushered in a period where bonds - and therefore liabilities - outperformed equities, causing (in addition to a lot of losses) a lot of soul searching about how investors should allocate assets and pick fund managers. In particular, Gardner says this led to a knee-jerk reaction to invest in anything other than equities, and to invest in different ways. The most powerful idea to emerge since then has been the long-term mandate.

Since then, a few practitioners of long-term investment have caught the industry's eye. The UK's University Superannuation Schemes held a contest to come up with a 30-year mandate (won by Henderson's). Warren Buffett's Berkshire Hathaway's dedication to long-term investment has earned it a 12.2% p.a. excess return over the S&P500 - for 38 years. And Yale University's famed fund manager David Swenson's long-term approach netted the organization an excess return of 16% over the S&P500 since 1998 and a positive result every year, when the index was in the basement.

These institutions are laudable investors that demonstrate the wisdom of taking the long view. They offer other institutions lessons. But they are not models to copy, Gardner says. These examples have different liabilities and time frames. Yale's endowment is, in effect, aiming at perpetuity. It is not an insurer or pension fund with liabilities looming in the next 15 years. Moreover, how many institutions in Asia have the entrepreneurial instincts of Warren Buffett, or the freedom from pressure by stakeholders enjoyed by David Swensen?

So, yes, long-term investment is superior to chasing short-term market movements; in fact, the long-term player benefits from everyone else's inefficient scrambles. They also have more freedom to invest in illiquid strategies like private equity and have the luxury of riding out short-term market volatility.

But most investors are 'path dependent'. They have shorter-term liabilities to worry about. They face political realities in terms of the trustees they report to, or they lack the expertise or freedom to operate like Daid Swensen. Accounting regulations may require them to mark to market their portfolio regularly, which creates short-term disturbances on the corporate balance sheet.

If the fashion of long-term mandates needs a sceptical view, so does the recent anti-equities sentiment, Gardner argues. He says the long-term direction of equities remains upward - if it didn't we'd have to ditch capitalism altogether. But equities are more advantageous at particular points in time, and path-dependent investors need their strategies to reflect this point.

A large Hong Kong institutional executive agreed with these arguments. "I'd love it if I could give out a 10-year mandate. Then I could go golfing," he said.

Nonetheless, Gardner notes there are aspects to the Buffetts and the Swensens that all institutions would do well to note. In particular, these role models operate in an environment of good governance. They communicate well with stakeholders, they are transparent and they share mutual trust with their trustees.
Asian institutions often lack such a supporting environment. Government bureaucrats, amateur board members representing labour or other groups and the lack of paid independent directors makes it very hard for local managers to implement their investment ideas. When institutions see Warren Buffett and want to be more like him, trying to extend their time horizons can only come from building a more professional relationship within the organization and its relationship to trustees. Until institutions work on that, the process of picking good external managers can't be improved much to accommodate challenging market environments.

Tomorrow: managing bonds with the threat of rising interest rates.