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 only slowly as market participants are eventually forced to accept a new reality.
A short term approach is only ever speculation
While gains may be realised over 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 many of the greatest investors in history. 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 over the last 20 years as greater access to information and competitive pressures on professional investors has encouraged short term speculation over patient investment. This view is supported by data from the NYSE Factbook which shows that the average holding period of a stock on the New York Stock Exchange has fallen from 100 months in 1960 to closer to 3 months by 2012.
This trend towards hyperactivity and speculation naturally has an impact on the returns investors receive. As portfolio managers have 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 somewhat counter-intuitive 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 over 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% of the time. Equally those that were 4th quartile in one year were top quartile in the following year in 28% 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. An investor 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. The situation is like that of a poker player who takes small bets on each hand but is unlikely to ever win the prize at the end of the tournament.
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 the closet speculators.
This article originally appeared in Investment Adviser
