They can take advantage of signals that have a good track record of providing better than market returns over the long term, but which like many signals, can take time to deliver.
There is good academic work to show that for example, there is an exploitable anomaly in buying value stocks for the long term. Theoretical models tell us that any positive risk adjusted gain will be bid away and that opportunity to make outsize returns will be lost. And yet these anomalies persist. Why?
One argument is that the amount of short term money reacting to short term noise always outweighs long term, considered investors.
The rise of passive funds, where new money necessarily reinforces current market valuations could exacerbate the situation.
But if short term money is exaggerating a valuation mis-match, the argument for being long term (and then driving out the mis-match) becomes more compelling.
My experience tells me that there are an array of features in the way that money is managed in this country that impede organisations and managers truly following a long term strategy. I suggest three reasons.
1. Short term investors
First, demand. Fund buyers may have long term investment horizons but often make investment decisions based on much shorter time periods – almost never as long as a whole investment cycle.
Thus valuable information is lost to the buyer. Fund managers, who know that their customers judge them on shorter term performance are pressured into trying to fit their fund performance to these metrics.
2. Career risk
Second, managers manage money, but also, importantly, their careers. There is a career risk in straying too far from the investment crowd.
It is rational from a career perspective to continue to buy a stock or asset class that is meaningfully overvalued if it keeps going up.
Think back fifteen years. If you were true to your principles you might have avoided TMT but you performed miserably versus the market and your peers.
And then, before you were vindicated, your job was on the line. Why take the risk with the mortgage?
Get in comfortably with the herd, and maybe have 1 per cent less in Vodafone than the benchmark. You’ve made your point and it won’t cost you your job.
3. Lack of confidence
Third, long term investing is hard and takes a certain kind of confidence. It doesn’t matter how strong your conviction is, if you spend six months or a year, or even more, where your funds are lagging the market or your peers, it is difficult to resist the temptation to cave in and rejoin the “safety” safety of the crowd.
And after all, anyone in these investment markets who is 100 per cent confident is 100 per cent of an idiot.
Long term, value investing is not necessarily the only way to make returns. But if you believe that it adds performance, then make sure that your own fund selection processes are not part of the problem.
Look at performance over longer cycles. Look for managers who have invested through a few cycles and proved that they stick to whatever their discipline is.
Make sure you are getting what you want for clients and importantly, what they are paying for.
