Temporal Alignment in Investing

In meeting well over 200 investors and fund managers over the past couple of years, I have recognised something that separates the best from the rest: alignment. Alignment of interests, and alignment of time horizons. This post is on the latter.

Suppose a find has a long-term investment philosophy, e.g., an average holding period of 8 years. While raising funds, it is tempting to accept limited partners with shorter time horizons, in a quest to grow assets under management (and thus, fees). But doing so can wreck all sorts of havoc: furious clients begin calling after a quarter of negative returns or underperformance, not recognising the managing partner’s much longer outlook.

The very best fund managers I know turn down — refuse to accept — potential clients, when they sense misalignment. They focus instead on attracting aligned capital.

Say no to misaligned capital. One rupee of aligned capital is worth hundred rupees of misaligned capital.

— Mr Utpal Sheth (source)

Doing this is difficult in the short run, since it entails willingly forgoing fees. But in the long term, it imbues the fund with what my mentor calls temporal leverage: the ability to survive in order to thrive.

Consider Nicholas Sleep and Qais Zakaria, who co-ran the Nomad Investment Partnership and returned ~20% CAGR over 20 years.

They also took delight in turning away investors who seemed unsuitable or irritating, regardless of how rich they were. Zakaria chuckles at the memory of a comically awful meeting with a team that managed billions for heirs to the food-packaging company Tetra Pak. These financial advisers demanded access to Nomad’s proprietary stock research as a condition for investing their clients’ money in the fund. Zakaria says the atmosphere grew “frostier and frostier,” with Sleep crossing his arms and legs in a sign of mounting annoyance. After fifteen minutes, Sleep and Zakaria showed their visitors the door.

— Richer, Wiser, Happier by William Green

Mr Nicholas Sleep

Beyond investment management, I can think of 2 parallels of how misaligned time horizons cause problems:

1. Asset-liability mismatch (ALM) in banks and NBFCs. Nearly every banking and NBFC failure (apart from outright fraud) involves ALM: borrowing short term and lending long term. In theory, the lender can roll over their borrowings repeatedly. When the goings are good, this works perfectly well…that is, until the tide turns.
2. Companies that want to build for the long term are almost always punished by public markets (in the short term). Investing for tomorrow’s profit pools entails forgoing profits today: something not appreciated by most analysts and hedge funds, who prefer higher earnings next quarter. It is crucial to have shareholder-management fit, which is why Mr Sridhar Vembu — one of my favourite thinkers — makes it clear that Zoho has no plans to list anytime soon: they are building for the long haul.