How can long-term investors maximize their edge of strategic patience? In their November 2011 paper entitled “Investing for the Long Run”, Andrew Ang and Knut Kjaer offer advice on successful long-term investing (such as by pension funds). They define a long-term investor as one having no material short-term liabilities or liquidity demands. Using the California Public Employee’s Retirement System and other large institutions as examples, they conclude that:
- Long-term investors can:
- Ride out short-term fluctuations in returns.
- Exploit instances of short-term mispricing.
- Exploit high-premium illiquidity.
- The two biggest mistakes of long-term investors are:
- Procyclical tactical reallocation (shifting portfolio weights in the same direction as relative past performance instead of rebalancing to fixed weights or reallocating in a contrarian manner).
- Accepting investment manager/advisor goals (short-term performance fees) in conflict with a long horizon and “fake skills” that obscure risk.
- Long‐horizon investors should:
- Be rigorously contrarian by strict rebalancing to fixed portfolio weights, or more aggressively, to weights dynamically set by robust valuation‐based rules.
- Focus on diversification across socioeconomic factors (such as inflation, economic growth and political risk) and investment factors (such as value‐growth and momentum) rather than asset classes.
- Upgrade their own investment competence (understanding risk and reward) to support incentivizing, monitoring and evaluating investment managers/advisors.
- Demand elevated returns for illiquid investments as compensation for associated constraints on rebalancing.
In summary, evidence from institutional experience suggests that long-term investors should be contrarian, diversified across factors (anomalies) more than asset classes and knowledgeable enough to set long-horizon incentives for investment managers/advisors.
Though presented in institutional context, the advice likely applies to individual investing and smaller-scale investment managers.
Cautions regarding conclusions include:
- Reported evidence is weakly quantitative. It is difficult to analyze long-run investing quantitatively because samples are always short relative to investment horizon.
- To the extent the market is adaptive, returns of widely known factors diminish over the long run.
- To the extent that researchers snoop, out-of-sample factor returns are lower than those implied by simple historical analysis.
