Institutional pension funds and foundations-most obviously-have long-term investment horizons. What is less well-appreciated in the investment industry is that individuals have long-term horizons too. If anything, an individual’s task is more complex, since it is broken into a long capital accumulation phase and then, possibly, into a capital distribution period. (If capital accumulation is extraordinarily successful, some accounts never have a distribution phase. The portfolio sometimes just continues to accumulate because the spending never approaches the fecundity of the portfolio.)
Like a institutional pension fund, an individual’s retirement savings has a very long life span—because it is, in fact, your pension fund. A recent article by Andrew Ang of Columbia University and Knut Kjaer points out some of the chief advantages of long horizon investing:
Long horizon investors have an edge. They can ride out short-term fluctuations in risk premiums, profit from periods of elevated risk aversions and short-term mispricing, and they can pursue illiquid investment opportunities. The turmoil we have seen in the capital markets over the last decade has increased the competitive advantage of a long investment horizon. Unfortunately, the two biggest mistakes of long horizon investors—procyclical investments and misalignments between asset owners and managers—negate the long horizon advantage. Long horizon investors should harvest many sources of factor risk premiums, be actively contrarian, and align all stakeholders so that long horizon strategies can be successfully implemented. Illiquid assets can, but do not necessarily, play a role for long horizon investors, but investors should demand high premiums to compensate for bearing illiquidity risk and agency issues.
I put their recommendations in bold. For individuals, aligning stakeholders shouldn’t be a huge problem. You’re the only stakeholder, which is another advantage over an institution.
It makes perfect sense to harvest multiple factor risk premiums. Historically, relative strength is among the largest of these, but lots of them are worthwhile. Value is a well-known factor and minimum volatility also seems promising. A big benefit of these two factors is that the excess returns are often negatively correlated with relative strength. You can build better equity exposure by combining uncorrelated factors.
Finally, they suggest being actively contrarian. I read this as being willing to add to a strategy when it is out of favor, something they euphemistically term as “short-term fluctuations in risk premiums.” When relative strength has underperformed, add to it. When value has underperformed, plump up your portfolio in that area. Although the fluctuations can often be hair-raising, they are very correct about what a big mistake procyclical investments can be. (Procyclical is just a fancy word for buying high and selling low.)
Their conclusion is also worth reiterating: The turmoil we have seen in the capital markets over the last decade has increased the competitive advantage of a long investment horizon.
As an individual investor, you have some handicaps relative to institutions. But if you work from the standpoint of a long investment horizon, you also have a big potential competitive advantage. Whether you turn that potential into reality or not is a function of how successfully you implement their recommendations-constructing a portfolio to capture several return factors and adding to a strategy on dips.
