2016 has been a year of considerable market noise: Turmoil over China at the start of the year has been followed by political disruption in the form of Brexit, and now the US election. Fund managers have had much to distract them, but many would argue that they should be able to see through short-term turmoil. Do they? To what extent is short-termism a problem for investors?
Average holding periods across the market have fallen
The prevailing view is that investors are too short-term, therefore fund managers are too short-term, and therefore companies are too short-term. Earlier this year, Neil Woodford, founder of Woodford Asset Management, called short-termism ‘frustratingly rife’ in fund management, arguing that it hindered the UK’s institutional investment industry’s ability to hold executive management teams to account.
Gavin Haynes, investment director at Whitechurch Securities, says: “Investors are becoming more short-term in terms of wanting rewards and not accepting periods of underperformance or that markets go through cycles.”
This is seen in asset flows: only a handful of fund managers can persuade investors to stick with them through their weaker moments, while others have to watch assets fall away.
This creates problems for the companies in which they invest. If fund managers are being judged by short-term performance statistics, they are more likely to impose it on company management teams. This means companies may target short-term earnings over and above longer-term investment. Corporate investment levels remain low, which in turn is seen as a key barrier to productivity improvements. In this way, short-termism is a drag on economic growth.
A Threat to Prosperity?
Politicians and academics have highlighted the problem: US Vice President Joe Biden has called short-termism ‘one of the greatest threats to America’s enduring prosperity’, while the UN has suggested that short-termism is a barrier to companies embedding socially responsible and environmental concerns into their business.
Chris Hills, chief investment officer at Investec Wealth & Investment, believes that short-termism is also proving a problem for certain investment strategies: “Contrarians effectively become momentum-watchers. They recognise that if a company’s share price is going down, there will be ten sellers to every buyer and if they try and buy in, they could see real weakness. As a result, increasingly they don’t do anything on the way down and try and wait until it turns.”
It has been a problem for value-focused managers as well. Increasingly, says Haynes, investors are unwilling to accept the period of underperformance that inevitably accompanies a value strategy. He says: “Good value managers look at mispriced opportunities. It can take some time for that catalyst to be realised and investors need to be patient.” This phenomenon is evident in the performance of funds such as the Schroder Recovery fund, which had a difficult year in 2015, but has had a good year in 2016.
UK Funds Show Low Turnover
This all sounds very bleak, but not everyone agrees that short-termism is a universal problem. For example, in August of this year, the Investment Association (IA) looked at turnover across different IA sectors as part of an investigation into trading costs. It found ‘no evidence that fund managers overtrade’ – an indication of short-termism. Certainly, there were sectors, such as the China, Europe including the UK, and North American sectors where turnover was higher, but for the UK All Companies sector, portfolio turnover was a relatively modest 28%, compared to 11% for a tracker.
It concluded: “if it were the case that investors were systematically suffering from poor active management, excessive trading and ‘hidden’ implicit transaction costs, we would expect to find poor realised outcomes as well as very high portfolio turnover levels and, as in previous research, the results clearly do not show this.”
Average holding periods across the market have fallen, but this may be the influence of a few very short-term traders, such as high-frequency traders. This has been argued by academics such as Martijn Cremers, Ankur Pareek, and Zacharias Sautner, who suggest that holding periods for mutual funds and pension funds have not change significantly.
What Should Investors Do?
With this in mind, how should investors approach the problem? Even if it is not universal, short-termism can have an impact on returns through higher trading costs and poor market timing. As such, Haynes ensures that his ‘core’ holdings are all with fund managers who take a long-term approach and have low turnover of between 10 and 20%.
This is managers such as Neil Woodford, Nick Train at Lindsell Train, Richard Pease at Crux or James Anderson at Scottish Mortgage Investment trust (SMT) who generate their competitive advantage by knowing the companies in which they invest intimately and ignoring short-term factors.
He says that while there is a place for shorter-term ‘trading’ strategies, it is more in the absolute return or hedge fund area.
There are regulatory changes in the offing, such as the Financial Transaction Tax, which may force a longer-term approach on investors. Short-termism and its impact on productivity is increasingly capturing the attention of policymakers. The fund management industry and the behaviour of investors might find itself increasingly under scrutiny.
