Are large institutional investors pro- or countercyclical? Do portfolio shifts by the world’s largest asset owners respond procyclically to past returns, or countercyclically to valuations? And if countercyclical investment (with both market-stabilizing and return-generating properties) is a public and private good, how might asset owners be empowered to do more of it?
Examining central bank, pension fund, insurer and endowment portfolios totaling USD 24 trillion, this study1 finds that portfolio changes are typically procyclical. In response, the author suggests that a framework aimed at jointly bolstering long-term returns and financial stability should: (i) embed governance practices to mitigate ‘multi-year return chasing;’ (ii) rebalance to benchmarks with factor exposures best suited to long-term investors; (iii) minimize principal-agent frictions; (iv) calibrate risk management to minimize long-term shortfall risk (not short-term price volatility); and (v) ensure regulatory conventions do not amplify procyclicality at the worst possible times.
We believe that the recommendations in this study make a lot of sense, but we are afraid that procyclical behavior is so deeply rooted in human nature that it will prove very hard to bring about these changes.
1 Jones, “Institutionalizing Countercyclical Investment: A Framework for Long term Asset Owners”, IMF working paper no. 16/38, 2016
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