Data from year-end 2022 shows the investment horizon gap between companies and investors 1 remains slim, though for the first time since our tracking began, investors are leading with longer investment horizons than companies. On paper, closer alignment of investment horizons between providers and users of capital may appear to be a positive development for value creation in capital markets. However, ‘closer’ doesn’t necessarily equal ‘better’.
While the past year reflects a continued long-term upward trend in investor horizons, it also revealed a material decline in investment horizons for corporates. This raises questions about the potential for corporates’ long-term value creation. Specifically, the material reduction in corporate investment horizons over the last two years brings them to their lowest value since FCLTGlobal’s tracking began. Furthermore, the increasing horizons can be attributed more to changes in portfolio composition than to a fundamental shift in investment behavior. It is important to note that the effects of these trends vary significantly across geographies, sectors, and even within asset classes. We highlight a few of the key drivers in corporate and investor investment horizon changes below.
Companies’ investment horizons shortened in 2022
Companies in 2022 underwent a notable shift in investment strategies, resulting in companies shrinking their investment horizon. This reduction, from 5 years 4 months in 2021 to 5 years in 2022, was primarily driven by two key factors: an upsurge in buybacks and a decrease in retained earnings. As businesses increasingly opted to repurchase their own shares and allocate fewer funds to retained earnings, they experienced a shorter-term orientation to capital deployment. This shift reflects a changing landscape, indicating a stronger emphasis on immediate return of capital to investors in the corporate world.
Spotlight on buybacks and retained earnings
Globally in 2022, despite an overall 17% decrease in total uses of capital, buybacks emerged as an outlier, showing both an absolute and percentage point increase compared with previous years. Companies reached an unprecedented high of $1.29 trillion in buybacks, indicating a substantial upward trend compared to the curbing that took place during the start of the pandemic in 2020. The surge in buybacks can be attributed to favorable monetary policies and companies’ accumulation of excess earnings and cash on their balance sheets since 2021.
US companies have underpinned this buyback spree in recent years, as have the Finance and Information Technology sectors globally. In 2022, the Energy sector played an outsized role in buybacks as rising prices generated higher earnings while fossil fuel companies continue to implement their climate transition strategies. More broadly, this data highlights a trend among corporates, particularly in the US, to strategically invest in their own stocks by allocating excess capital towards buybacks while enjoying substantial financial strength.
Yet recent assessments indicate that buybacks may not have been the most prudent use of capital. According to Fortuna advisors, a financial consultancy, the return on investment (ROI) for buyback programs hit the lowest on record for any five-year period since they began tracking the metric in 2017. Additionally, buyback programs are inherently reliant on a bullish market to produce significant value. However, with increasing market volatility, companies need to determine whether continued significant spending on buyback programs is the right move, or risk over-catering towards the immediate short-term return of value to their shareholders.
This data only includes asset managers as this data is currently available. The savers data (i.e. pensions, insurance companies, households, SWFs etc.) typically come out later in the calendar year. Check back here in December for fully updated information.
As fiscal and monetary policies tightened in the second half of 2022, there has indeed been a slowdown in buyback activity, with the amount spent on buybacks peaking during Q1 2022. Companies’ inclination to “buy high” during periods of peak stock prices has also contributed to this tapering off, and it is especially interesting that at this same time, companies have begun spending more on capital expenditures. Heading into H2 2023, it will be important to monitor how companies choose to spend their capital, and its subsequent effect on corporate investment horizons.
How the changing environment (rising interest rates) affects retained earnings
Retained earnings and cash both decreased as earnings were deployed elsewhere
The changing economic environment has also prompted corporates to materially reduce retained earnings in favor of other uses such as interest expense due to rising rates. It has led corporates, especially in sectors like financials, real estate, and information technology, to start spending the precautionary cash reserves held on their balance sheets for pandemic and resilience efforts over the last two years.
This shift in uses of capital does carry risk. Less cash on hand can mean less resilience in the event of negative shocks – as seen in the recent collapse of Silicon Valley Bank, the Russian invasion of Ukraine, and the pandemic. In particular, the financial sector has seen a substantial decline in retained earnings. This might foreshadow reduced resilience and future sector challenges, consistent with the rise in bank downgrades and negative outlooks.
One solace for capital deployment is the continued increase in research & development (R&D) spending, as innovation funded by R&D is a critical driver of long-term value creation. Throughout the pandemic, R&D spend has been the only use of capital to have increased both in percentage and absolute value year-over-year. We see in Figure X (chart above) that the information technology and health care sectors have led the way, especially during the early pandemic. The generalized boom over the past decade in R&D spending includes spending for advancements like the human genome project, CRISPR, and advances in AI and climate tech.
Investors’ seemed to become longer-term in 2022
Unlike their corporate counterparts, overall investor horizons increased from 5 years 3 months in 2021 to 5 years 5 months in 2022. However, this improvement resulted not from lower turnover and improved long-term management practices, but from a rise in the underlying share of indexed equities and longer duration in fixed income instruments.
Public equity investment horizons have gotten longer-term overall – but not due to lower portfolio turnover
Public equity investment horizons lengthened by 6 months year-over-year between 2021 and 2022. The primary driver was a shift in equity composition from active to indexed strategies, as the latter have much longer investment horizons.
Here it is worth noting that turnover increased in actively-managed portfolios as well as some indexed portfolios, which would normally lead to shorter investment horizons.
Indeed, the downturn and turbulence in stock markets in 2022, combined with the strategic repositioning of portfolios, led to higher turnover in active equity portfolios investment and caused investment horizons for these assets to decrease from 2 years 10 months in 2021 to 2 years 7 months in 2022.
In contrast to active equity, overall turnover for indexed equities is marginally lower in 2022, implying investment horizons are slightly higher. Underneath this aggregate number, however, the uptick in volatility led to more major index rebalancing, with more companies added to and removed from indexes, increasing turnover.
There is a similar nuance to the fixed income investment horizons, which increased from 4 years 8 months in 2021 to 4 years 10 months in 2022. However, it is worth noting that not all subclasses experienced a lengthening of investment horizons and durations.
Interest rates have increased significantly across many jurisdictions in 2022, leading to higher volatility to the asset class overall. However, higher interest rates have notably different effects on different subclasses of fixed income instruments.
Specifically, the durations of instruments like mortgage-backed securities and asset-backed securities tend to increase as rates rise due to lower expected prepayments. We see that MBS durations have indeed increased from 3 years 9 months in 2021 to 6 years 3 months in 2022. By contrast, higher interest rates for corporates tend to have the opposite effect, as it becomes more costly to roll over debt and companies look to alternative sources of capital. We do see that corporate durations have decreased from 6 years 3 months in 2021 to 5 years 6 months in 2022.
What to make of the horizon gaps?
Narrow gaps and longer horizons aren’t necessarily indicators of strategic long-term behavior
The data indicates that corporates are adopting shorter-term investment strategies and alarm bells should be ringing. Though the gap between the investment horizons of corporates and investors remains small, and investors appear to have gotten longer-term in 2022, this doesn’t necessarily imply a positive change, as it may not reflect longer-term behaviors on the part of investors. Overall, it is essential for both corporates and investors to carefully evaluate their strategies to ensure they align with long-term value-creation and financial resilience.
5 December 2022 - FCLTCompass is an annual benchmarking tool tracking long-term investment behavior on a global scale. The results of the latest analysis suggest that investment horizons receded in 2021 due to global disruptions such as inflation and COVID-19 recovery efforts.
6 December 2021 - FCLTCompass tracks long-term investments on a global scale. The project anchors long-term investing to quantitative data reported in years and dollars, framing the conversation around sustainable finance in a more actionable light.
7 December 2020 - FCLTCompass is an annual reporting of money as it flows through the global investment value chain. Taking 10+ years of financial data, it traces investors’ savings through various asset vehicles, finally arriving at the companies that deploy it in support of economic growth.