In the information age, investing can seem like a game where you need to make all the right moves all the time. At an investment conference I attended recently, one of the presenters used examples of how humans have been genetically wired through 3.7 million years of evolution to focus on short-term risks or perils – the kind we absorb from the media every day.
A well-known annual study links this fear factor to investing. Conducted by Dalbar Inc., the study shows how poorly investors have performed compared to the S&P 500 (on average) due to investment decisions driven by short-term risks. It also indicates that knee-jerk investment trades leave about 1.5% of annual returns on the table.
Professional advice and education have been shown to improve the quality of trading decisions, but something as simple as rethinking your approach to long-term investing may be a real game-changer.
The long and the short of investment strategy
Almost every investment product that is introduced to the market includes the feature of liquidity – the ability for the investor to cash-out the investment quickly. While liquidity is definitely important in certain circumstances, it is often not needed and may compromise the benefits of long-term investing for investors and portfolio managers alike when used inappropriately. For investors, it enables detrimental snap investment trades, often driven by market anxieties. Managers, in turn, need to accommodate for unpredictable redemptions in the short-term.
There is an emerging alternative. Investors who have the patience to put a portion of their money in illiquid or partially-liquid investments, and leave it alone for years as opposed to months, weeks or days, can potentially benefit from three important advantages:
- Imposed discipline that blocks ill-considered trades
- Flexibility for managers to set strategies that generate the most long-term value
- Access to additional diversification and potentially higher returns from some private asset classes (as opposed to publicly-traded asset classes) that, by their nature, cannot always be liquid
Private asset classes make patience attractive
To illustrate the potentially higher returns of private asset classes, let’s look at one of our oldest funds as an example: the MD Stable Income Fund. The Fund has a long history of investing in high-quality commercial mortgages and loans that pay a premium (currently around 1.85%) over bond returns. The extra return we receive is driven by the private nature of the loans, and reflects the fact that we cannot easily sell them. Can you get all of your money out right away if you want to? Usually, but not always—however, investors in this Fund have been willing to commit their money for a longer term in exchange for this extra return.
Most recently, we extended our private asset class investment offering with MD Platinum Global Private Equity Pool. With a minimum holding period of 10 years, this new Pool executes a long-term strategy of value creation in carefully selected private companies. The Pool offers an institutional-level investment strategy and primarily focuses on fund investments into venture capital, buyouts and distressed assets.
The goal is improved diversification, as well as higher cash flow and return on assets than investments in publicly traded companies, which are always under the microscope of short-term performance to keep shareholders happy. In other words, managers of privately held companies can set ambitious long-term strategies without the interruptions and distractions experienced by the managers of public companies.
Major Canadian pension plans, such as the CPP and the Ontario Teachers’ Pension Plan, have adopted similar long-term strategies that invest in illiquid assets. My most current estimates for the MD Platinum Global Private Equity Pool indicate a potential premium of 2% over typical stock market investments. Historically, a comparison of the two asset classes has shown an even wider spread.
Naturally, a 10-year minimum commitment for a portion of investment funds is a serious decision requiring professional advice. For many investors, however, it would be a desirable course of action.
Patience leads to real returns
By extolling the benefits of long-term investing commitments, I’m not coming out against liquidity; in fact, almost all of our investments feature daily liquidity. However, given the potential for additional return while avoiding the pitfalls of short-term trading, a healthy dose of illiquid private investments can go a long way to boost the return potential of a well-diversified portfolio.