Investing For The Long Haul

A future-driven, more sustainable economic model is needed.

The massive monetary and fiscal responses to the financial crisis seem to have successfully fended off the threat of a new Great Depression. Yet while growth rates bounce back and deflationary pressures recede, analysts are beginning to question the sustainability of the ongoing recovery without coordinated structural reforms to the financial system.

This coordination enables them to spread best practices, and encouraging them to establish new partnerships would have undeniable merits. This reasoning has led the French Caisse des Dépôts et Consignations, the German Kreditanstalt für Wiederaufbau (KfW Bankengruppe), the Italian Cassa Depositi e Prestiti and the European Investment Bank to create the Long-Term Investors' Club in early 2009.

Deep imbalances, rather than simple business cycle effects, are at the very heart of the credit crunch. Stimulus programs, focusing on tax breaks and liquidity injections, may have brought the economy back from the brink, but they have failed to address fundamental issues. As such, these stimulus packages might lead us back to "business as usual" mode with the unacceptable risk of another, more intractable crisis around the corner.

Pro-cyclical accounting standards and largely inadequate financing choices translated into investor shortsightedness. Redeploying investment objectives over a longer-term horizon and redesigning the current regulatory framework at an international level will be key to fostering robust and sustainable growth.

The role of capital markets is to help private or public entities raise financing and to let investors trade securities or exchange information. Adopting a long-term approach is necessary, not only as a means to stabilize market gyrations, dampening volatility in times of turbulence, but also to protect companies against disruptive changes in stakeholder control and to allow for the undertaking of more ambitious industrial projects.

But weighing in on increasingly globalized markets requires more than deep pockets and the willingness to act. Long-term investing, while solidly entrenched in European tradition and burgeoning fast in other parts of the world (as illustrated by richly endowed sovereign wealth funds), has proved insufficient to prevent the past crises. Without a high degree of coordination at both the operating and the normal levels, little good will be achieved.

So-called mark-to-market and mark-to-model techniques have shown their limits in the build-up to and during the financial storm. While applying the former reinforces current price trends artificially by systematically equating the value an asset to its latest market quotation, the latter merely ignores the real world, relying instead on financial theory and simulation.

In valuing an asset, sound accounting norms should achieve two objectives. First, they ought to reflect the current liquidity regime of the market by estimating the amount that an outright sale would generate. Second, they should not distort the incentives of market participants by supporting excessive price swings, rally or rout, appraising realized and unrealized stakes indiscriminately as do the latest International Accounting Standard Board's proposals. The only functional solution that could aptly satisfy both criteria consists in taking investment horizons into account, thereby treating the holdings of high-frequency traders and lasting investors differently.

This method, coupled with a new set of corporate governance rules favoring long-term players in the decision-making process, would duly protect companies and shareholder value. Financial regulators are ultimately responsible for introducing and imposing this business-model approach to accounting: They should aim at doing so at an international level, bridging the gap between rival Financial Accounting Standards and International Accounting Standard boards, in line with the more-integrated nature of markets.

Far outgrowing its initial European scope, the Long-Term Investors' Club perimeter now ranges across the entire world. Lately, the Paris Conference for Long Term Value and Economic Stability saw other North American financial institutions join this endeavor--such as the Canadian pension fund Wording Omers and the Caisse de Dépôt et Placement du Québec--as well as others from the Middle East, North Africa, Russia and China.

Armed with a combined balance sheet of $3 trillion and a distinctive mandate, Long-Term Investors' Club members have already committed capital to a series of strategic ventures such as the InfraMedand the Margueritefunds--European initiatives designed to strengthen Mediterranean and European infrastructures while promoting environmental responsibility and rewarding long-term management.

To achieve its objectives, the Long-Term Investors' Club needs a new, stabilizing regulatory framework to act as a catalyst in the ongoing transition to the long-term-oriented, more sustainable economic model the world so desperately needs.