Introduction
The Overinvestment Theory of Non-Monetary Investments (OTNM) is a widely used investment decision-making tool by asset managers. The theory revolves around the idea that when an investor is overly cautious and pessimistic about the returns from a specific asset class, or overly optimistic about the potential gains, the outcome of their investments will most likely be suboptimal. This can be applied not only to monetary investments but also to non-monetary investments such as physical capital, human capital, technology, and environmental resources. This paper seeks to explain OTNM, provide empirical evidence to support it, and consider its implications for the asset management industry.
Overview of OTNM
OTNM, which originated in the early 2000s, is based on a few fundamental assumptions. Firstly, it suggests that investors often overinvest in non-monetary investments due to overly pessimistic or overly optimistic estimation of potential returns. Secondly, it proposes that while non-monetary investments have the potential to generate higher returns than cash or debt investments, these returns are not guaranteed and hence subject to market risks. Finally, it suggests that investors tend to focus on short-term returns when making investment decisions, which can be a major cause of suboptimal outcomes.
Empirical Evidence for OTNM
Though OTNM is widely accepted and used, there is limited empirical evidence that definitively proves its validity. In a study on the effect of capital investment on shareholder value, researchers found that when investors underinvest in physical capital, the firms market value and profits are lower than those of firms that invest optimally. The study also suggests that the benefits of capital investment are greater when investor optimism is higher. However, the findings were inconclusive, as the study only found a weak correlation between investment and returns, instead of a direct causal relationship.
Other studies have compared the performance of firms with medium-term and long-term oriented investment strategies. These studies suggest that firms with medium-term orientations are more successful in responding to short-term market conditions but fail to outperform those with long-term orientations in the long run. The findings of these studies could be interpreted as an indication that investors tend to focus on short-term returns when making any investment decision and that this approach can often be suboptimal.
Implications for Asset Management
The consequences of OTNM are particularly relevant for asset managers, as they need to be aware of the risks associated with investing in non-monetary investments. OTNM warns against being overly optimistic or pessimistic when making investment decisions, as these can lead to suboptimal outcomes. Asset managers need to have a clear understanding of the potential risks and rewards associated with their investments and make well-informed decisions accordingly.
In addition, OTNM is relevant for asset managers as it provides them with guidance on how to go about balancing their portfolio. A portfolio should include a mix of investments, including both monetary and non-monetary investments, in order to maximize the potential rewards while minimizing the risks. This can be achieved by taking into account the returns, risks, and other characteristics of the various asset classes before deciding on the optimal allocation.
Conclusion
The Overinvestment Theory of Non-Monetary Investments (OTNM) is a widely used investment decision-making tool by asset managers. The theory proposes that investors often make suboptimal decisions when they are overly pessimistic or overly optimistic about potential returns. Though empirical evidence is limited, there are studies that suggest that OTNM is valid, and its implications for asset management should not be overlooked. By considering the risks and rewards associated with each asset class, asset managers can make well-informed decisions that maximize returns while minimizing risks.
