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Long-term and sustainable financial investment

The Financing for Development agenda has emphasized the importance of long-term “stable private financial flows to developing countries” since the Monterrey Consensus (para 25.) At the same time, there has been a growing focus on the incorporating environmental, social and governance (ESG) factors in investing. The Addis Ababa Action Agenda brings these two strands together, emphasizing that sustainability and stability of the financial system are mutually reinforcing. Yet, to date, capital markets remain short-term oriented. As shown in the chart, in the USA, for example, the average holding period for stocks fell from 8 years in the 1960s to under a year in 2015.

Long-term investment

Corporations also increasingly focus on short-term indicators, such as stock price fluctuations and quarterly profits, with many business executives reporting they feel pressured to demonstrate short-term performance. A 2016 survey of senior executives found that more than half of the respondents felt pressure to perform within a year, up from 44 per cent three years earlier. A McKinsey index of corporate performance found that short-termism has been rising since the turn of the century, despite a fall prior to the 2007 global financial and economic crisis.

Institutional investors

Institutional investors have been looked to as a potential source of long-term financing for sustainable development, both because of the size of assets under management and because of the long-term liabilities of some investors, which should enable the longer-term investment necessary for sustainable development. Assets under management by Institutional investors amounted to USD 115 trillion in 2015. Institutional investors with longer-term liabilities, such as pension funds, life insurance companies and sovereign wealth funds together hold around USD 78 trillion. However, for a number of reasons, even institutional investors with long-term liabilities have tended to allocate investments to liquid assets and invest with a relatively short-term investment horizon, with low allocations to the long-term illiquid assets necessary for sustainable development.

Mapping of financial flows
 
As investment moves through the investment chain, intermediaries are increasingly removed from the end investor (e.g. the pensioner), and the incentive structures become less and less aligned with those of the end investors. In particular, while the pension fund might have long-term liabilities that are well suited for long-term illiquid investments, such as infrastructure, the hedge fund or private equity fund managed by a third investor often has very short-term liabilities, which are not well suited for these investments. 
 
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Many also incorporate a greater degree of short-term incentives in compensation. The fee structure (of a 2 per cent management fee and 20 per cent performance fee) is characterized by asymmetric returns – managers have a potential upside monetary gain but no downside penalty when losses are realized. This asymmetry provides incentives for managers to increase risk and leverage in order to boost short-term returns. Other institutional factors, including the existing structure of staff evaluation, and internal decision-making, governance, and firm structure can also limit long-term investment.

Financial Institutions
In recent years, the international community has taken important steps to strengthen the resilience of the financial sector through regulatory reforms, such as the Basel III capital and liquidity requirements. While these measures have been aimed at reducing systemic risks and enhancing the stability of the financial system, the Addis Agenda also points out the possibility of unintended consequences including adverse effects on the cost of finance to smaller enterprises and a reduction in the availability of long-term financing or financing for the higher risk investment often necessary for sustainable development.