in your interest
THE INVESTOR
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Balance sheet
Long-term investments usually offer the best rewards,
but it is often difficult to avoid short-term decisions, which lead to
market volatility. And with the Prince of Wales criticising the short-term
approach, investors are encouraged to view setbacks with a cool head.
companies to raise finance in order to invest for the long
term – is not working as well as it did.
Kay argues that the fragmentation of the equity
market, with over 40 per cent of shares now owned
by overseas investors and the increase in rapid
trading, especially the algorithmic‘high-frequency
trading’ determined by computer programmes, have
all contributed to the breakdown in the traditional
partnership between investors and the companies, from
which both used to benefit.
In NewYork,Will Browne, managing director of
Tweedy, Browne, agrees that investment horizons
have shortened in the past five to 10 years.‘Time
horizons in equity markets have contracted dramatically,’
he says. ‘As a result, turnover in markets across the
board, from individuals to asset managers, not to
mention high-frequency trading, is at an all-time high.
The immediacy of information, coupled with a focus
on gaining a short-term trading edge, regardless of the
information’s relevance to the long-term prospects of
a business, is a significant contributor to the volatility
in markets.This increased volatility is corrosive,
undermining investors’ trust in markets.’
Kay thinks it is vital to restore this trust, arguing
that we have moved away from a culture in financial
services that was based on relationships to one based on
transactions and trading. In his report, he emphasises
that the interests of companies and investors should
be aligned.‘The goals of equity markets are to operate
and sustain high-performing companies and to earn
good returns for savers without undue risk.The two
perspectives are essentially identical. In the long run,
the profits earned by high-performing companies are the
only source of returns for savers who invest in equities.’
By their very nature, markets can go through periods
of over- and under-valuation. Browne provides a fund
manager’s point of view.‘When [shares are overvalued],
you give to the guy who is more optimistic,’ he says.‘You
peel it off slowly as the value begins to distance itself
from the stock. If the stock price comes back and the
value reappears, we will put some investment back in.’
For investors likeTweedy, Browne, short-term,
rapid movements in share prices are just part of the
overall cycle.They can be annoying, but it’s just noise.
And while many investors are looking at short-term
movements in the share price,Tweedy, Browne spends
time focusing on the underlying business, which enables
it to remain detached enough to concentrate on what
matters: the underlying value of the stock. Besides,
it argues, a low share price gives it a competitive
advantage, a chance to buy into a business it believes in,
at a discount to the rest of the market.
A drop in share price is also a chance to add to an
investment –Tweedy, Browne has added to its holdings
in Nestlé, the food and beverage conglomerate, several
times in this way over the past 20 years.
Chances of winning
In the short-term/long-term debate, one small but
important point is often overlooked: dealing costs.
Everyone pays dealing costs, whether they are a private
or institutional investor. Repeatedly trading a portfolio
ratchets up the costs.
It’s even worse if those decisions turn out to be
wrong.Warren Buffett, the long-term value investor,
likes to use the analogy of anAmerican football team.
If it wants to increase its chances of winning, it must
avoid making mistakes, such as fumbling the ball at a bad
time. Buffett says that buying shares in a good business
and hanging on for the long term is a better strategy than
flipping stocks.
In terms of portfolio turnover, it’s certainly true that
the stock market does look as if it has become shorter
term. For UK equities, the overall average holding period
has declined since the mid-1960s from around eight
years to just seven and a half months
1
. However, this
measurement is misleading, because it is heavily skewed
by a high number of smaller trades around the margins of
the statistical base and does not reflect accurately the fact
that the majority of institutional shareholders tend to hold
stocks for periods of well over a year, sometimes several.
If investors can sit back and view short-term blips
and setbacks as an opportunity to buy, rather than to
panic, and screen out the market noise, the expectation
is that, barring a major unpredictable event, equities will
continue to outperform bonds and commodities.
1 Professional Adviser, 21 November 2013
