Journal of Financial Economics

REF 108 Long-term investment

The economic crisis which began in 2008 caused a decline of global savings, while emerging and developed economies have considerable needs in long-term investments. In France, three fields are identified: integrating young people into the labour market and financing their projects, supporting innovative SME’s and promoting major technological innovations. At the same time, a demographic upheaval is compounding economic disturbances. Aging will increase the scarcity of savings and mobilize specific long term investments for the elderly. In this context, better fiscal incentives and risk sharing between corporations and the public sphere would raise long term investments.

While the current account imbalances are increasing between major economic areas, most industrialized countries are experiencing a rapid aging. Faced with a growing world population, these differences could undermine the funding of productive investments. This article successively explores the role of contemporary current accounts, of FDI and international portfolio investments and at last of demographic factor. With the exception of some industrialized countries able to maintain an efficient domestic productive system, the majority exhibits a relative decline to the benefit of emerging countries, including their ability to attract foreign savings. The United States differ by the volume and structure of their international capital flows. Overall, more aging in industrialized countries is increasing, the less their savings deficit, but probably at the expense of their economic growth. From a macroeconomic perspective, the life-cycle theory would therefore be checked only as a transitory phenomenon.

One of the main characteristics of family capitalism is a long term perspective, linked to a willingness to ensure continuity and intergenerational transmission. Long term investment and family capitalism are thus linked. Building on the specificities of family businesses, this article explores the link between investment and family capitalism under two main aspects: the attitude of family businesses towards their own financing needs, and the attitude of families as investors in other businesses.

Savers evolve today in a difficult environment : financial and economic crisis, macroeconomic risk related to the future of the welfare system, tax reforms, Welfare State reform seeking to further empower the individual... Consequently, savers invest in safe and short-term assets at the expense of long-term and risky investments. Moreover, this prudent behavior could also be accelerated by the recent increase in the limits on savings accounts. According to some, these trends could lead to a problem of financing the economy.

Using individual data, we show that this prudent behavior does not concern everybody: wealthier and older people hold a large fraction of their wealth in risky and long-term assets. In addition, prudence behaviors during the crisis was due to lower expectations regarding incomes and stock prices of assets, a more pessimistic outlook of the future on the labor market, not to an increase in risk aversion.

So, in order to encourage investors to take more risk, one scenario would be that the State (Welfare) continues to protect individuals against new macroeconomic risks.

Venture capital is a long run investment that aims at fostering radical innovations and at increasing the innovative capacity of firms. The United States are by far the country that is the most innovative and the one that invests the greatest amount in venture capital whereas Europe and France stay behind. The explanations to the underinvestment in venture capital in France rely on the mismatch between demand and supply, the low expertise of venture capitalists and on the weak development of seed capital. We suggest policy measures to foster the development of an efficient venture capital industry that creates innovation.

Private equity funds provide firms with long term funding that enables them to achieve growth. Investors in such funds are subject to illiquidity constraints as the length of these investments is five to seven years on average. This illiquidity is rewarded with a return superior to listed equity. Whereas French households invest most of their savings in short term products, the efficiency of the Public Sector initiatives to direct part of these savings towards the private companies deserves to be highlighted.

The strategic asset allocation is a key pillar for the long-term investors who face the necessity to reconcile the long-term risk-return objectives and the need for short-term protection. This article explains why the long-term investors have to go beyond the standard asset management framework of fixed weights allocation. Rooted in the financial theory, dynamic asset allocation appears to be a very relevant investment solution. The different types of dynamic strategies are presented and the concept of diagram payoff is introduced as a powerful tool to reveal investor’s preferences. We also illustrate the role of accounting rules and the setup of a proper governance to reach the long term objectives.

Traditionally, public sector involvement in infrastructure projects has been large. More recently, pre crisis abundant liquidity lead to blur the specificities of long term investment projects (undertaken by public and private sponsors). However, the financial crisis shed a new light on these specificities while public sector involvement has been reconsidered from a normative perspective and challenged by a tighter fiscal constraint and the search for a more efficient intervention. This questioning brings forward four dimensions in the public sector involvement: it has the responsibility to ensure that a proper socioeconomic evaluation of the project has been conducted; it can provide public financing and subsidise the project (when the socioeconomic evaluation concludes positively that the project is worthwhile but the return from a private sponsor perspective would be to low to undertake it); it could help coordinate the various stakeholders and need to tailor its interventions in that respect; it could provide a suitable regulatory and supervisory framework for a new asset class to develop and attract other investors while ensuring a proper handling of associated risks.

The growth potential of Europe lacks long term investment fitted to the transition towards a more sustainable model of development and to an exit to the crisis. In the context of the development of socially responsible behaviours of households, firms and investors, the implementation of economic policies favourable to long term investment could trigger a virtuous circle in terms of mobilization of public and private financing resources.

Nevertheless, filling the financing gap depends not only on the mobilization of savings but also on the efficiency of the financial institutions in terms of intermediation and transformation of savings. For this reason, public authorities have to set a regulatory framework – prudential and accounting – well balanced between, on one hand, the necessary protection against systemic risks and soundness of financial institutions and, on the other hand, the financing needs of the real economy. In this perspective, the preservation of the diversity of the financial ecosystem is a key point in order to ensure its efficiency and its resilience to crises.

While risk aversion remains at very high levels in the throes of the crisis, the need for long-term investment has perhaps never been so urgent. Advanced economies, in particular, must resolve this dilemma in order to return to their pre-crisis growth path and revert to sustainable public debt trajectories. But long-term investors have become a rare species and there are a number of factors – economic, regulatory and fiscal – that are not particularly incentivising. These investors have also lost their marks as the hierarchy of risk seems to be less stable ; asset managers and other financial intermediaries only partially meet their requirements. Long-term investment is seen to be a positive factor for financial and monetary stability and this stability itself contributes to creating a favourable environment.

To resolve the euro zone crisis, a growth model mobilizing a European-wide generic innovation is needed. Environment conservation and adaptation to climate change nurture such principle if the European Community agrees upon a social value of carbon enabling the creation of carbon assets. Then potentially profitable investments must be financed. However investors are impeded by risk aversion, regulations and accounting standards. To overcome the dilemma, we show that regulations and standards must be adjusted so that investors get incentives to buy long-term assets. We also point out that a financial intermediation involving the central bank and a Green Fund may help diversification of investors in financing carbon assets.

The current economic crises reduce governments’ room for manoeuvre on infrastructure finance. At the same time banks withdraw from on-balance-sheet long term lending and the monoline credit insurance system has virtually collapsed. Pure public or private solutions should not be viewed as panacea. Channelling savings to infrastructure projects require both public and private involvements: a regulatory framework conducive to long term investments, risk sharing based on an acute risk analysis, public infrastructure banks providing long term lending and the development of infrastructure and project bonds.

According to a recent OECD study, the global needs for infrastructure investment amount to 40,000€ billion by 2040. Faced with the scarcity of public funds, the financing of these needs is seen as a burden or a challenge, at a time when austerity is required even if the term itself is still taboo. Yet, through the existing legal and financial tools that are PPPs or concessions, the state has the capacity to use the private sector to ensure funding of projects to meet the fundamental changes in contemporary societies. But many obstacles remain for private investment, and especially the mobilization of capital over the long term. Infrastructure is requiring stable and sustainable investments. That is why the needs in economic and social development largely depend in the future, on the ability of states to shift long-term savings and to rely on specialized actors to fill the «  infrastructure gap ».

This article reinterprets the euro area crisis by reviewing mechanisms to share economic risks within Economic and Monetary Union (EMU). The euro was expected to foster flexibility and convergence of national economies, and it was believed that national fiscal policy alone could address adverse economic shocks. The outcome was very different. In the first years of EMU, risk-sharing developed mainly through financial markets. Policy did little to induce flexibility or convergence and national fiscal institutions malfunctioned. The global financial crisis and the sovereign debt crisis then impaired the market-based risk-sharing mechanisms. Since flexibility or convergence had not been achieved, and national fiscal policy could not provide self-insurance, the two crises left the euro area with insufficient risk-sharing arrangements. The actions of the ECB and other public institutions can only temporarily fill this void. For EMU to be put on a sound and durable footing, market-based risk-sharing mechanisms must be restored, flexibility and convergence must be fostered, and national fiscal policy must act responsibly. New European institutions are desirable as a complement to – not as a substitute for – policy action at the national level.

Since 2008 some industrialised countries, including the United States and the United Kingdom, have been facing liquidity trap problems and have implemented Quantitative Easing (QE) measures in an attempt to improve financing conditions in their overall economy. Although Quantitative Easing policies primarily act upon long-term interest rates and asset prices, they also have secondary effects on exchange rates. In a “currency war” context, some countries might be tempted to use QE as a protectionist weapon in a bid to achieve exchange rate depreciation. After identifying which QE transmission channels affect exchange rates, the paper proposes an empirical analysis of stylized facts and econometric tests on the United States.