17 October 2016
It seems to me that most people struggle to do nothing – it appears to take a lot of effort. And this is good news because in many aspects of life, an active day-to-day approach is generally the right one to adopt, whether it’s our health, relationships or the upkeep of the family home.
The danger is if that activity acts as a deterrent, deliberate or otherwise, to addressing anything other than the here and now.
Nowhere is this more apparent than in investment management, where efforts designed to increase long-term value creation by companies and by the economy as a whole often come a poor second to tinkering focussed on the possibility of generating short-term portfolio gains.
Why is this?
Well, the reality is that investment managers find it as hard as anyone else to sit on their hands. But their short term focus is probably also down to issues which are specific to investment and to the mandates managers are asked to oversee.
First, managers’ performance is typically measured over the short-term (or at least they think it is) and often against the wrong thing. Second, the relationship between asset owner and asset manager can be weak and uncertain. Therefore, as a manager, you will feel the need to impress and to do it now. And third, internally, asset managers may be incentivised in the short rather than the long term – those potentially flighty assets may not hang around.
A portfolio constructed in this environment often has a number of undesirable characteristics. For example:
- A high level of turnover and consequently high costs – after all, if a stock doesn’t perform, get shot and get another one.
- Overdiversification – building confidence in a stock, and therefore the size of the holding in it, can just take too much time.
- Short term mind set – if stocks are seen as something to hire for a short period rather than to own longer-term it is no surprise that this focus is not conducive to developing the mind-set prepared to commit time and effort – via stewardship and engagement with management – to enhance overall company value.
The most valuable job investment managers do for investors, and for society as a whole, is to help allocate capital (both between and within companies). This is why they should think through carefully where longer-term capital can grow and equally importantly where it will be destroyed. If fund managers have this focus, then so can the companies in which they invest.
So what would characterise a portfolio built to deliver in the long term?
- A low level of turnover – keeping trading costs down.
- Not over-diversified with stocks being held just to control risk versus the index. There should be a good long-term investment case for every stock in the portfolio.
- The manager would exercise strong stewardship over its holdings – the immediate response to problems would be what has been termed “voice” – attempting to improve things in the context of the relationship – rather than “exit” – selling the investment.
- The mandate to run that portfolio would reward the manager in the longer term, framed around a clear understanding of what both parties – asset manager and asset owner – can expect from one another.
Why not ask your fund manager what they see as the fundamental economic / societal developments over the next decade and where these are reflected in their portfolio. That should start a lively debate on matters like demographic change, technological disruption and climate change (is there anyone that seriously believes that oil and gas companies will still be doing what they do today in ten years’ time? Or if they are, will they be worth very much? If in doubt, ask the coal industry and refer to the recently ratified Paris Agreement on climate change). If you are met by silence, you might want to think about the manager’s long-term place in your line up.
Our principles and checklist will help you see through the noise and focus on the long term – download here