Investors Aren’t Countercyclical—But They Should Be

Investing’s golden rule might be to buy low and sell high—but it’s one to which even the most sophisticated investors have trouble adhering.

In spite of their long time horizons, institutional asset owners largely tend to make procyclical investments, the International Monetary Fund’s Bradley Jones found.

According to the study, US pensions, endowments, and insurers on average displayed both a failure to rebalance in the current year and a tendency to chase performance long term. They increased exposures to equities when stocks have outperformed other asset classes in the current and prior years, and behaved similarly with fixed income investments.

Conversely, portfolio weights were negatively correlated to real yields of equities and fixed income relative to other asset classes.

“These results… suggest countercyclical motives are not a key determinant of portfolio changes for large asset owners,” Jones wrote.

To decrease procyclical investing, Jones suggested five structural and policy changes that would encourage institutional investors to behave counter to the market.

First, he recommended strengthening governance practices to ensure that trustees and stakeholders are understanding and supportive of long-term objectives, even at the cost of short-term losses.

“Higher levels of financial literacy among fund stewards would lend greater support to investment staff who might otherwise have difficulty in advancing the case for increasing exposure to asset classes that have performed poorly in the recent past,” Jones wrote.

Funds should implement custom benchmarks tailored to their unique liability and risk profiles, the author added, and tilt toward the types of risk premia for which they are best suited.

Risk management focused on long-term shortfall, as opposed to short-term volatility, and mitigating procylical financial regulation would also support countercyclical behavior.

Finally, asset owners need to better align their interests with managers to support a mutual goal of long-term gains, Jones argued. Lockup arrangements could empower managers to invest without fear of being fired after short-term losses, while more symmetric fee structures—wherein the manager is exposed to the downside as well as the upside—could ensure a stronger commitment to returns.

“Investment with a patient, countercyclical focus holds out the prospect of jointly bolstering returns for individual asset owners, and contributing broadly to a more stable financial system,” Jones concluded. “The pursuit by long-term asset owners of a ‘double bottom line’ would appear to be in both the private and public interest.”