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 figure, in the USA, for example, the average holding period for stocks fell from 8 years in the 1960s to under a year in 2016.
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.
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There is no clear definition of long-term investment. It is often described as financing with a maturity of one to five years (see Pu Shen).
However, this cut-off is much shorter than what is needed for investments in long-term projects, such as infrastructure, which have economic life spans that can range from 15 to 40 years. Furthermore, defining long-term by the maturity of an asset can be misleading. Investors can sell longer-duration liquid instruments in secondary markets, turning a long-term instrument into a short-term investment. For example, during the global economic and financial crisis, some investors who were considered to be long-term investors were forced to sell their positions prior to the end of their investment horizon due to a lack of liquidity, bringing about a collapse in the price of assets being sold.
The Task Force has therefore not focused on the maturity of the instrument, but rather on i) the investment horizon of the investor or the investor’s willingness to hold a position; and ii) the investor’s ability to hold a position. The first element is in line with the view of long-term investing associated with “patient” capital and ‘buy and hold’ strategies. The second relates to the investor’s liability structure, including degree that investments are financed with borrowing that is significantly shorter term than the investment itself. Thus, pension funds, which have long-term liabilities in the form of future payments to pensioners, tend to well-suited to invest in long-term infrastructure projects as long as they don’t take on a high degree of short-term leverage.
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 (excluding banks) amounted to $112 trillion in 2017. Institutional investors with longer-term liabilities, such as pension funds, life insurance companies and sovereign wealth funds together hold around $71 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.
An integrated assessment of the possibilities and impediments to mobilizing long-term investment for sustainable development can be undertaken through a flow-of-funds framework from sources of funds to uses and outcome.
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The journey from one end to the other end is, however, far from straightforward. Funds can flow through different routes (e.g., directly to companies or through financial intermediaries, such as institutional investors of financial institutions) and investment outcomes create new savings, leading to another round of what is, in effect, a cycle. There is also the possibility for money to circulate in both directions, creating churning in the system. Some asset owners also invest through secondary financial intermediaries (such as a pension fund investing through a money manager). The result is a chain of intermediaries; while the ultimate beneficiaries (e.g., pensioners) may have a long-term outlook, the intermediaries often have progressively shorter-term incentives that are ultimately not aligned with the owners of capital.
Finally, there is a range of other actors, such as investment consultants, rating agencies, brokers, and regulators that help guide investment decisions and set incentives within the system. The incentives and impediments faced by all the actors in the financial chain will determine the magnitude, time horizon and quality of investment, with implications for incomes, employment, and social and environmental outcomes.
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.