Short-term investing is an oxymoron.
Investing can only ever be long term in nature as it relies on a combination of vision, discipline and compound returns.
Investment opportunities typically arise slowly over time in response to the behavioural biases of investors and recede slowly as market participants are eventually forced to accept a new reality.
While gains may be realised in short time periods, this typically represents either the correction of a valuation anomaly, or a market where participants are borrowing returns from the future. A short-term approach can therefore only be categorised as speculation.
The problems caused by speculation being disguised as investment are hardly new and have been commented on by some of the greatest investors.
John Maynard Keynes identified the over-activity of investors as long ago as the 1930s: “Our decisions to do something positive… can only be taken as the result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”
While short-termism is an entrenched problem, the trend has accelerated during the past 20 years, as greater access to information and competitive pressures on professional investors have encouraged short-term speculation over patient investment.
This view is supported by data from the NYSE Factbook which shows the average holding period of a stock on the New York Stock Exchange had fallen from 100 months in 1960 to closer to 3 months by 2012.
This trend naturally has an impact on the returns investors receive. As portfolio managers become ever more focused on short-term returns, the performance of their portfolios necessarily become more random and the long-term results less predictable.
The conclusion is that the greater focus on quantitative analysis, which has promoted a short-term approach, has itself undermined the predictability of returns by encouraging investors to pursue random outcomes.
The same is true when analysing fund managers. An emphasis on short-term returns as the key assessment metric is likely to reduce the predictability of long-term returns. This may be simply illustrated by examining the returns of a short-term fund selection strategy.
Using data from the IMA UK All Companies sector, we tracked the quartile rankings of funds during a 20-year period. This showed that funds delivering first-quartile returns in one calendar year only maintained that top-quartile record for a second year 43 per cent of the time.
Equally, those that were fourth quartile in one year were top quartile in the following year in 28 per cent of cases.
Against this background, it is more important than ever to undertake a qualitative assessment of the managers of potential holdings and their ability to withstand short-term underperformance in the pursuit of a sustainable long-term investment strategy.
It is equally important to consider the culture in which a manager works. Some fund management groups are clearly more supportive than others.
A manager who feels compelled by his superiors to deliver short-term returns is unlikely to have the freedom to accept the risk that will deliver the best returns.
Only by undertaking a holistic assessment of the manager, the process and the environment in which they work will the adviser be able to guard their clients’ capital against closet speculators.
Dan Kemp is co-head of investment consulting and portfolio management at Morningstar Investment Management (EMEA)
