12/11/2008 - 22:00

Striking the right investment balance

12/11/2008 - 22:00


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SHORT-TERMISM has something of an Orwellian ring to it, so I reckon it's appropriate to blame it for undermining the free-market economy.

Striking the right investment balance

SHORT-TERMISM has something of an Orwellian ring to it, so I reckon it's appropriate to blame it for undermining the free-market economy.

Right now, as the world explodes with government intervention and capitalist greed cops the blame for everything that's going wrong, I thought it was time to turn readers' attention to what I think is the fundamental root of our problems.

I believe the time horizon for people's expectations on financial outcomes has shortened, putting an unrealistic strain on performance demands.

This short-term thinking is most obvious in the mainstream investment management community, which operates at best on a 12-month outlook.

Speak to any director or CEO and you'll find most believe that big stakeholders impose a huge burden on them to produce growth. They use benchmarks across sectors and industries to push company leaders to chase their peers, whether they believe the outcomes are sustainable or not.

Many in the executive class have benefitted from this.

They use financial modelling to predict future growth and price that into the market today. This has a lot of outcomes, but one is the crystallisation of rewards. Options come into the money, bonuses become bigger and the riches loom large.

Paying people today for generating returns in the future is fraught with danger, as any small business owner knows.

It would be easy to point the finger at investment managers, but the problem is a lot bigger than that.

Short-termism has swamped financial decision-making at every level, not to mention most political thinking.

These days, even people buying their first home expect to reap a profit in the short-term, rather than being grateful they can finally convert rental payments into long-term financial stability.

Certainly, the housing markets in general have become captive to asset traders rather than simply those who are seeking a place to live. Investors now have a huge hold over the residential property sector and many buy and sell on a whim.

Investment managers could also argue they are driven by individual superannuation account holders and their financial advisers, who demand growth above the benchmarks ever year.

By definition, someone has to lose in these circumstances, prompting accounts to shift and good performers to be rewarded with growing funds under management.

And the more winners there are the more money is flushed into the system, prompting asset inflation to create yet more winners.

It is a cycle of big rewards available in the short term, encouraging many to leverage the outcome by borrowing to increase their exposure to property, share markets and other investments - thus multiplying its impact.

Despite the increased risk associated with such activity, the short-term nature of this gamble had two negating effects.

Firstly, people were prepared to take the risk because they believed the gain was so easily attainable, in terms of time.

It's much easier to expose yourself for a short period of time because we tend to believe that we have more clarity regarding the conditions we are operating under. The longer the period of engagement the more likely, we believe, that outside factors can alter the course of our investment.

So getting in and out quickly becomes the name of the game, as many in private equity showed.

Secondly, if things went wrong, the short-term nature of the attempt meant another opportunity could arise in relatively short time frame. In other words, it's easier to risk everything if you believe you'll have another shot at it in the near future.

Those who lost everything in the tech wreck, for instance, were back into it during the recent mining boom. Two opportunities to make a fortune in a decade may well lull people into believing there are many chances offered to them in life.

To some degree we ought to be grateful the recent turmoil proves that risk does exist and very few can see where the danger lurks.

Maybe the current financial shock, with the potential for a major impact on the real economy, could alter this type of thinking born of taking safety and security for granted.

It is only those who consider the future who put something away for a rainy day.

On the bright side, in these times of turmoil, the views of those who invest for longer-term are being vindicated.

Warren Buffett, for instance, is increasingly seen as the guru because he invests in companies that create lasting value.

Over-leveraged private equity players that were stalking the investment markets have disappeared, returning the focus to the long-term plans of company leadership.

Interest is rising in professions that have a lot less to do with instant financial rewards and far more link to long-term gratification in terms of lifestyle and vocation.

These are all good signs.

However, there is a danger in all this.

One is that those who don't like free markets will seek to regulate for long-term thinking. Just how that is done, I don't know, but it could seriously impinge on the flexibility of those who innovate for the longer term as well as the short term.

And there is always the problem of the pendulum swinging so far towards the long term that we fail to recognise short-term problems, as many a visionary business executive has come to understand - in hindsight.

What we want to do is get the balance right. Where the risk-and-reward ratio is appropriate and each one of us is focused both on today and the long-term horizon.

History tells us such a balance is hard to achieve.


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