“I don’t think anyone is thinking long term now.” Thomas Mann
It is interesting that even Thomas Mann, German novelist, social critic, and Nobel Prize winner in 1929, would already worry about people’s short-termism during his tumultuous years. It seems that things have not changed and almost 100 years after his words, we should worry again that social and technological contingencies are pushing us to short term decision making rather than taking the long term view.
Short-termism is affecting many areas of our lives but it is certainly most apparent in financial matters. From the daily nuisance of CNBC to analysts’ obsession with companies’ quarterly numbers, short-termism is spreading everywhere. Investors of all kind are not immune either; professional investors are now generally not more inclined to a longer term view than the often criticized retail ones. To this point, Morningstar, a well-respected research shop, reveals that the average holding period for stocks in the 25 largest mutual funds in the U.S. is now only 1.4 years. Interestingly, the long term view in investing is usually quickly resumed as a convenient slogan during any significant correction; retail investors who would have otherwise quickly taken profits, during a correction suddenly declare a long term faith in their investment ideas. This strategy switching conveniently avoids the embarrassment and physical pain of actually taking losses. On the other hand, professional money managers, make sure to remind their retail clients that investing is a long term game and only by staying fully invested at all times, can gains be produced; this in spite of their own somewhat contradictory portfolio turn-over.
In light of such pervasive action, one should wonder if perhaps the short term view may actually be more beneficial than the much more boring long term approach. In fact, we do have evidence of higher benefits from long-termism in many areas of social development, including portfolio management.
Keith Ambachtsheer, in his interesting article “The Case for Long-Termism,” published on the Rotman International Journal of Pension Management, traces the roots of social success to that tipping point in time when mankind switched from a short term strategy of day to day survival to one of long term wealth creation. Initial survival needs forced mankind to implement very short term decision making; in financial terms, Ambachtsheer defines this situation as one where the discount rate for saving and investment decisions for a time frame longer than the immediate present is very high. However, as progress helped produce more than it was needed in the current time reference, discount rates started to fall and long term decisions became prevalent ensuring a rapid advancement of our civilizations.
Perversely, long-termism may be the victim of its own success. As technology and social organization become more and more complex, additional intermediate agents are needed to manage the intricacies of daily life; this proliferation of agents often leads to a misalignment of interests and reward mechanisms along with an increase in asymmetrical information. For instance, think of the executive managers that lead a company but may not own it; because of their frequent reporting duty to investors who, conversely, own but not manage, the managers’ interest will inexorably lead toward short term actions regardless of any long term benefit. This contingency is much like the politician’s situation where any long term decision carrying short term pain would be deemed, from a career perspective, suicidal or like BBC fictional UK Prime Minister Jim Hacker would euphemistically say “courageous.” Interestingly, one solution devised to overcome this problem—rewarding managers with stock options to increase their stake in the company they managed and align them more with the stockholders—resulted in an even more significant inclination toward short-termism. Decision making ended up being driven purely by the rhythm of quarterly results. Very reluctantly, a trend toward linking executive pay with long term performance rather than quarterly results is now under way.
However, from an investment management perspective, managers’ reward and clients’ performance expectations are still deeply rooted in short-termism.
While fixing managers’ incentive structure may encounter resistance, the formula to use in the future may be rather self-evident. What may be more difficult to change is the pervasive investing mentality poisoned by emotional biases, media self-interests, and an understandable fear of the long term unknown.
In the past, we have indicated a number of relatively simple practical solutions to mitigate the damaging inconsistencies caused by the noise surrounding the investment process. Conversely, Ambachtsheer highlights three major common themes he detected in his research of successful investment outfits:
- Articulate a clear stance
- Think as if you were investing directly in a business
- Balance conviction and humility
Articulating a clear view of the ultimate goals and processes to achieve such targets is key in sidestepping classic mistakes produced by short term emotional biases. Ambachtsheer, in his work, found that being out of step with the short term mainstream was not only acceptable, but actually viewed as a competitive advantage.
The following point is a favorite of many successful money managers, among others Warren Buffet, as it clearly forces an investor to focus on the long term viability of an investment and its proper valuation rather than being swayed by price fluctuations of the day-to-day action. Thinking of an investment in the market as if one were buying an actual operating company, rather than just acquiring stock certificates, will redirect one’s attention to the actual business fundamentals and operational dynamics.
The third theme goes right to the heart of most emotional biases. Many investors often lack conviction in their investment processes and therefore become subject to short term noise with the result of damaging their long term performance. On the other hand, many other investors tend to overplay their conviction mode and rarely accept that perhaps a mistake was made and corrective action might be in order. Walking the fine line between confidence and reality, between discipline and smart flexibility, is a must in determining the success of any investment framework.
In the course of modern investment history, practical examples of the long term advantage can be found in different cases. Ambachtsheer quotes John Maynard Keynes’s track record when managing the Cambridge University endowment in the 25-year span from 1921 to 1946. Keynes’ strategy was based on an overweight in stocks (unheard of at the time) chosen based on fundamental metrics and with a history of dividend paying. Keynes also preferred to concentrate his portfolio only in positions he felt strongly about and that he could hold for a long time. During his tenure as the investment manager for Cambridge, he earned an average annual return of 16% on the discretionary part of the Endowment fund versus 10.4% and 7.1% respectively for the British stock and bond indexes.
In our own research, we have found that certain specific strategies do benefit from a longer term approach. Value based portfolios are a classic example of situations where the longer the investing horizon, the better results tend to be. On this point, James Montier of GMO has been writing extensively; in back-testing across different time frames his results seem to indicate that a longer time horizon is often required to allow markets to arbitrage such value discrepancies. Montier found that while value outperformance can be realized as quickly as in one year periods, a five-year investment horizon seems to help magnify the value/growth delta to a significant 40%. Along the same lines, for instance, Berkshire Hathaway uses a rolling five-year performance of the Standard and Poor’s Index as its benchmark in an effort to match its longer term investing commitment. Even more extreme is the example of the Singapore Sovereign Wealth Fund that publicly maintains a 20-year horizon for value creation. Finally, we should also mention the Yale Endowment model whose success was based, among other metrics, on the ability to arbitrage in the long term those short term dislocations that reoccur in financial markets.
It would seem that investment performance, like fine wine, does get better with age.
Bio: Davide Accomazzo is the Chief Investment Officer for THALASSA CAPITAL LLC, a Registered Investment Advisor and Family Office. He is also Adjunct Professor of Finance at the Graziadio School of Business and Management at Pepperdine University in Malibu, California. Mr. Accomazzo writes extensively on markets and portfolio management issues for different specialized publications and he is one of the contributors to the book Alternative Investment: Instruments, Performance, Benchmarks, and Strategies, part of the Robert W. Kolb Series in Finance. Mr. Accomazzo resides in sunny Topanga, California, with his daughter and wife.
