A Deeper Look into the Long-Horizon of DB Plans

A study by Willis Towers Watson argues that long-term horizon investing can generate as much as a 1.5% premium per year.

By Javier Simon | June 30, 2017
Page 1 of 3

A recent study by Willis Towers Watson (WTW) suggests that a long-horizon investor can stand to gain a net premium return of up to 1.5% annually depending on the asset manager’s size, strategy and governance. The research revolves around the idea that long-horizon investing offers significant opportunities for return, while downplaying drags on return. It identified eight building blocks or strategies for long-horizon investing.

These building blocks were applied to two hypothetical defined benefit (DB) pension plans. The smaller one, with $1 billion in assets, focused on lowering costs and avoiding mistakes by reducing manager turnover and avoiding chasing performance, while moving parts of its passive exposure into smart beta strategies. The net benefit of these strategies was potentially an annual increase in investment returns of about .5% per year. The larger scheme, with $100 billion in assets under management, had the governance and financial resources to employ all strategies and achieved a potential increase in returns of 1.5%.

“Most investors, if not all, would agree that those who are able to take a long-term view have a competitive edge over others,” says paper co-author Liang Yin. “I would summarize that competitive edge as the ability or skillset to identify long-term opportunities and the willingness or mind-set to maintain position in the face of short-term performance volatility.”

The report suggests creating portfolios that actively invest in companies that are focused on the long term as opposed to their short-term peers. It points to research by McKinsey Global Institute indicating that between 2001 and 2014, the revenue of companies with long-term outlooks grew on average 47% more than that of other firms, and with less volatility. WTW also recommends thematic investing and capturing systematic mispricing through alternative weighting schemes, or liability driven investing (LDI) glidepaths. It points to research concluding that “various mispricing effects via smart betas adds more than 1.5% per year relative to the cap-weighted index over decades of data.”

Matt Peron, head of global equity investing with Northern Trust Asset Management, tells PLANSPONSOR that alternative weighting schemes may pose less risk in long-horizon investing as opposed to thematic investing, however.

“You can pick factors that have long cycle lengths and higher return premiums such as value, and you can put that to your advantage,” Peron explains. “With factor-based investing, you have a rich, empirical data set going back to the early 1900s and you see fairly consistent patterns of return profiles of these factors. Thematic investing changes every decade. And you have to pick the right theme every time.”

WTW found that overall, return-seeking strategies were more suitable for larger plans with the resources and expertise to execute them effectively.

NEXT: Using a longer-term return analysis when firing managers