How to Separate Long-Term vs. Short-Term Parts of a Strategy

Just how can investors separate long-term from short-term segments of a strategy? Consulting firm WTW’s Thinking Ahead Institute has come up with an open-source computer code aiming at enabling allocators to do just that.

Investors have “become accustomed to short-term performance measures, which are perpetuated by traditional reporting methods,” said Tim Hodgson, co-head of the institute, in a report delineating the new method. The unfortunate result of their mindset is that “many investment mandates [are] being terminated for the wrong reasons and at the wrong time.”

The organization’s code breaks down a portfolio’s returns into three components: changes in market sentiment, growth in portfolio fundamentals and changes in the portfolio’s holdings. “This allows the evaluation of an investor’s decisions to be based not only on market-value returns, but also on changes in the fundamental attributes of the portfolio over time,” Hodgson explained.

The upshot, he continued, will be “improved conversations between asset managers and asset owners about the long-term return drivers of an investment strategy, particularly during periods of underperformance.”

The report notes that this initiative will be tested by members of the institute who are institutional investors: WTW, Baillie Gifford, MFS and S&P Dow Jones Indices.

The framework should work with all asset classes, although it may end up better at some than others, the report says. At the moment, it has been applied to portfolios that emphasize fundamentals, to better understand when there has been “a divergence in fundamentals and stock price performance.”

The report indicates that the method could well be employed in assessing environmental, social and governance investments.