A friend in the industry sent me a copy of this excellent paper: Ten Ideas to Foster Long-Term Investing. Its written by David Iverson and Dr Geoff Warren. Iverson is the Head of Asset Allocation at the hugely successful New Zealand Super. Dr Warren is an Associate Professor at the Australian National University in Canberra. Geoff is both a practitioner and an academic, having held various investment roles before entering academia. The Paper was sponsored by the Brandes Institute, a division of Brandes Investment Partners.

We found this paper to be really helpful for three reasons:

  1. Its written by people that have designed, built and managed long-term investment programs. They have real world experience.
  2. It captures the essentials of long-term investing.
  3. There’s a list of specific action items that investors can apply.

The paper lists ten ideas that are essential to successful long-term investing. Here are our key takeaways and observations:

  1. Ensure that principles are unambiguous about investment horizon

We’ve spoken to individuals that want to earn a return of inflation plus 5% (an aggressive return target in the current environment) and at the same time protect their capital. And we’ve seen institutions that have both short (i.e. beat competing funds) and long-term performance goals (i.e. high absolute returns).

These investors are kidding themselves. Long term investing often involves making a trade-off between short-term safety and long-term reward. Or short-term under-performance and preservation of capital.

Investors need to have a set of realistic expectations.

  1. Stick to your knitting

Every investor has their own set of circumstances, skills, experience and resources. What may be appropriate for one investor might be a terrible idea for another. This fact has several important implications:

  • Listening to stock tips or copying the investments of friends or family is usually a bad idea.
  • Conventional wealth management advice (i.e. risk profile a client and recommend a pre-mixed portfolio to suit) will be OK for most people. But it may lead to unsatisfactory results for people with a unique situation.
  • We shouldn’t speculate on things we know little about. Daniel has a childhood friend who’s an experienced computer programmer. He’s also a keen investor. But instead of investing in technology companies where his skills and experience can help, he speculates on small mining companies. Daniel’s finally helped him to understand that this doesn’t make any sense.
  • Diversification is a protection against the unknown. Sometimes it makes sense to diversify less in areas where you have knowledge and expertise.

Investors that have a competitive “edge” in a particular area should incorporate that edge into their investment strategy. And they investment professionals that they work with should help them to do this. Instead what often happens is the client gets pigeon-holed into a generic risk category/model portfolio.

  1. Slow down the decision cycle

If you’re investment horizon is ten or more years, what’s the rush? The authors make two important points:

“Further, the best long-term opportunities typically evolve over time, rather than arriving with a bank for a fleeting moment… Markets have often run further and longer than most expected: The mistake may be to act too soon.”

A good piece of advice is to “Always have “do nothing” or “wait” on the table as options – perhaps even as the default”.

  1. Reframe around progress toward objectives

The focus should always be on the investment process (i.e. what we can control) and how it relates to objectives, not performance (i.e. what we can’t control).

The way we present information can have a big influence on our reactions and our behaviour. The authors offer two suggestions. First, as long-term investors, we need to focus on long-term performance. This significantly reduces the volatility that we see, making it easier to stick to a long-term strategy. Second, focus on changes in income/cash flow rather than changes in our account balance.

  1. Touch, pause, engage

This is a no brainer. Frequent and open communication is needed to build trust, respect and a shared purpose. It’s impossible to make long-term decisions without this kind of relationship between the client and the professionals managing their money.

  1. Reward behaviour, not just performance

We are creatures of habit. Investors want to make sure that the professionals assisting them with their finances behave correctly. One way to do this is to look for and reward good behaviour, not just investment performance.

Warren and Iverson ask the question: “Why not observe and reward behaviour directly, rather than rely solely on performance as a measure of contribution?” They go on to explain why this is important: ”Doing so helps overcome one of the big challenges of long-term investing: that investment performance may not flow immediately from actions taken.”

  1. Police the information perimeter

We ‘ve all heard the saying: “You are what you eat”. The same principle applies to investing. If you consume short-term information, you are more likely to make short-term investment decisions.

It’s critical that investors think carefully about the information that they base their investment decisions on.  This is especially important as there’s so much “free” information available (the irony that In Brief is a free newsletter is not lost on us…). Free information can lead to costly decisions if it takes our focus away from the disciplined execution of our investment strategy.

An investment framework is an excellent tool to help investors determine the information that they need to pay attention to. It helps us to ignore a lot of useless information. And it also helps investors manage that nagging feeling that they might be missing something.

Remember, you’re not really missing any information if it doesn’t help you achieve your objectives or fit with your investment strategy.

Note: Someone has to be responsible for this. It won’t happen on its own. Groups are especially at risk since shared responsibility may lead to diminished accountability.

  1. Make incentives conditional on sustained performance

Another no brainer. Paying the professionals that help you for short-term performance when you have long-term objectives doesn’t make sense.

Also, where’s the skin in the game? Making performance fee vest over a period of time (subject to clawback provisions if circumstances change) is a good idea.

  1. Employ patient, farsighted people… and offer them careers with purpose

Many investment institutions struggle to do this. The main culprits are misaligned incentives and principal and agent conflicts (i.e. what’s good for the business/career isn’t necessarily what’s good for the client).

We’ve found that a great way to create a career with purpose is to start your own business. You need patience, drive and an entrepreneurial spirit. You’re accountable for your work. And your business will only succeed if you’re creating value for your clients.

  1. Manage the behavioural flaws

In general, behavioural biases can distract from the long-term mission through: heightened concern with short-term outcomes and short-term loss; overweighting of information that is more recent and readily available; creating propensity toward action and overreaction; herding and groupthink.”

Note: Someone has to be responsible for this. It won’t happen on its own. Groups are especially at risk since shared responsibility may lead to diminished accountability.

 

 

Grioli & Co. is an Authorised Representative (001258470) of Heuristic Investment Systems (AFSL: 276762).

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