Capital Markets Prioritise Near-Term Gains over Long-Term Profits

Growing wealth is never a near term prospect.  It requires planning over an extended investment horizon.  Part of that planning requires consideration for untoward challenges such as economic downturns.  Recently, that included the lockdown brought about by a global pandemic.  Most people lack wealth, many people lack savings, and some even lack income.  As such financial planning for the long-term needs to look at the problem from an income perspective, then savings, and then we can talk about wealth challenges. 

These challenges at a policy level lead to income disparity.  The wealthier a person is, the greater the opportunities he is exposed to, the greater his financial education.  Over generations, with their networking, this leads to the entrenched income disparity of many communities.  When that income disparity is too large, it becomes a threat to the cohesion of the community because sections of it become disenfranchised.  When they are disenfranchised, they no longer feel that they are stakeholders in the growth and prosperity of the community.  This economic instability becomes political instability. 

Addressing income disparity on a societal scale is driven by policymakers.  However, it is still the responsibility of the individual to get financial advise for himself, and his family.  For his household, the fundamental function of this financial advise is to find efficient ways of deriving savings from income, and turning that income into wealth to be grown, and managed.  The extended investment horizon required for the individual and for household is measured in decades.  The contention here is that the investment horizon of securities and assets in which these savings are invested in is measured in shorter periods of time, in the form of years, months, or even weeks.  This needs to be considered in the financial planning process, when savings are turned into security. 

What this means in real terms is that the savings invested, while the intent is for many years, decades, are often in assets and securities that have an investment horizon of five years or so, an intermediate investment horizon.  This means they are actually bearing a higher risk than they would actually be able to undertake.  The capital markets are not actually structured to meet those long-term investment horizons because fund managers need to be compensated now, not then.  That means these very fund managers would prioritise a shorter term horizon over the longer term one to take profit share.  That means keeping those assets in these funds, extended until they meet that time objective, actually puts them at a disadvantage, and there  is significant opportunity cost.  Investment decisions made for the long term disadvantage those made for the shorter term, and vice versa.  Fund managers are taking their cut now, which means a lesser gain for the longer term.  This is the result of mismatched priorities. 

This problem is the same for companies as well.  Like individuals and household, companies have long term and short term needs, and allocate capital accordingly to meet those needs according to projections.  However, since capital markets still prioritise the near term over the long term, they lose much more, in real terms, because of that opportunity cost.  Companies, unlike individuals and household, also need to project for political risk and currency exposure, exacerbating the problem.  Companies investing over the longer term normally have an investment horizon of seven to ten years, not decades, like households.  However, the market’s dollar weighted average for standard asset classes, equities, properties, and futures, is, at most, five years.  It is a lot shorter for money market.  The only longer term ones are debt instruments, but they do not keep up with inflation over that investment period, since that is not what they are meant for. 

This near term focus of the capital markets leads to cyclical bubbles and periodic crashes.  They are tolerated because those who control the most capital use it to seize market share during these periods, fuelling further cyclical instability until there is a major crash, requiring market intervention.  There needs to be a paradigm shift in how we see the markets, and policy should be shaped to balance it out.  In a properly regulated market, asset managers and asset owners also invest to meet the long term investment horizon of clients, from households to major pension funds, to family trusts.  Companies are encouraged to invest in their future, in infrastructure and product development, as opposed to prioritising stock options and shareholder needs.  This drives the economy and grows GDP.  That is not happening now. 

In many markets, from the US to Singapore, we need to close that wealth gap.  We need to push for the sort of activist investment that shrinks that gap in investment allocation.  What we have now is often massively inadequate, and forces companies and trusts to shorten their own investment horizon for short-term gain at the expense of long-term growth.  This goes against their own interests and the subverts market stability.  That investment horizon gap must be aggressively addressed at every level, from policy to the individual. 

For policy makers, that means more regulation in some areas to curb speculation and over-aggressive investment strategies, more dialogue with stakeholders, and a mix of a carrot and stick approach to encourage a positive movement in the market.  For companies, they should pursue their long-term goals for strategic growth, and they should build toward these long-term goals through day-to-day activities.  

Fund and investment managers need to be cognisant that there is a market for long-term investment horizons, and they can take advantage of it.  This is especially important when we consider the increased disruption risks of long-term trends such as climate change, changing demographics such as ageing populations, and technology advances.  While we are in the fourth industrial revolution, we should also be prepared for the quantum age, which is upon us.  Funds and asset management companies need restructure their compensation to incentivise seeking long-term gains over short-term profits, as a means of balance. 

For individuals and households, they need a better class of financial advisors, to provide them with the sort of financial education they need to understand their needs better, and match it to what is available on the markets, or at least adjust their strategy over time, if a longer investment horizon is not available.  There needs to be more attention paid towards how we structure plans for retirement over an extended investment horizon, and mitigate risk such as critical illness, and medical inflation.  That greater financial intelligence needs to be cultivated over time.  Financial literacy is a process, not just for individuals and households, but also for financial advisors.