Avoiding Short-Termism in

Investment Decision-Making

Jack Gray

Centre for Capital Market Dysfunctionality, UTS

Rawson East P/L
Brookvine P/L

CFA Seminar
April 2010
 Agenda
• Excessive short-termism is a sin
• Where does short-termism develop?

• All participants bear some guilt

• Long-termism has some benefits

• 5 steps to getting to and exploiting the long-

term

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One of Many

3
Short-Termism Can Be Costly

4
 Costly Indeed

“ … a swelling interest in investment

performance has created an
increasingly short-term oriented and …
more speculative market.”

Warren Buffett

5
 Costly Indeed

“ … a swelling interest in investment

performance has created an
increasingly short-term oriented and …
more speculative market.”

Warren Buffett (1969)

6
Long-Term Takes the Moral
High-Ground

7
Long-Termism Can Be Costly

8
 Costly Indeed
• Neither a panacea for investment virtue
- VHF hedge funds
- 25 vs 75 year-old

• Nor a paragon of investment virtue

- Disposition effect
- DB policy mix

9
 Excessive Short-Termism Is a
Problem
• Distortion of opportunities:
* Momentum  Private Gain, Public Cost
* Correlation: Qrt, Mo, Wk, Dy, …,Sec, …

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 Short-Term Valuation
£bn Profits Dividends Sales Assets MCap

Vodafone 1.3 0.9 6.7 1.0 214

Food Retailers
Real Estate
Gas Distribution
Alcoholic Beverages
Chemicals
Tobacco
Water
Construction & Building Materials 12.7 8.4 250.6 99.2 213
Healthcare
Engineering Vehicles
Diversified Industrials
Distributors
Print, Paper & Packaging
Household Goods
Oil Exploration & Production 343 companies in 15 sectors for the price of Vodafone

 10 9  37  99
As at 31/03/00; Source: GMO
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 Correlated, Yet Huge Swings
EAFE ex Japan vs. S&P 500
EAFE
1.2 ex Japan
+71%
Currency
+21%
1.1 S&P S&P EAFE S&P EAFE
+58% +96% ex Japan +80% ex Japan
Currency Currency +76% Currency +53%
+10% +76% Currency +25% Currency
Cumulative Relative Wealth in U.S. $ Terms

+50% +34%
1.0

0.9

0.8

0.7

0.6

Correlations: 0.67 0.22 0.55 0.44 0.61 0.86

0.5
May-73 75 76 78 80 81 83 85 86 88 90 91 93 95 96 98 00 01 03 05

Source: GMO, Standard & Poors. As of 6/30/06

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 Excessive Short-Termism Is a
Problem
• Distortion of opportunities:
* Momentum  Private Gain, Public Cost
* Correlation: Qtr, Mo, Wk, Dy, …, Sec, ..

• Churning destroys wealth

• Substantial value permanently destroyed

& transferred in extremes

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Ever Shorter Short-Termism

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No Contest: Turnover vs Returns
942 US Equity Mutual Funds: 10 Years to Feb 2005

180% 12.0%
160% 11.5%
140%
11.0%
120%
100% Turnover (LHS) 10.5%
80% Pre-tax Returns (RHS) 10.0%
60%
9.5%
40%
20% 9.0%

0% 8.5%
MER: 1.0% 1.1% 1.3% 1.3%

Source: Bogle
 Churn, Baby, Churn
‘Value’ Chain: Market Fund Investor
US Equity Mutual Fund Annual Returns 1983–2003
14% 77% of Market
12%
48% of Market
10%

Return 8%

6%

4%

2%

0%
Market Fund Investor

16 Source: Bogle
 We’re All Guilty
Scurrilous Survey
Player Guilty of Short-Termism?
Media 89%
Government/Regulators 81%
Financial Planners 81%
Consultants 68%
Members 64%
Trustees/Fiduciaries 53%
Investment Managers 27%
Corporations/Analysts N/A
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 So Is Long-Termism Virtuous?
“... to make the purchase of an investment
permanent might be a useful remedy for
our contemporary evils. For this would
force the investor to direct his mind to the
long-term prospects and to those only.”

“ … it is the long-term investor, he who

most promotes the public interest, who
will in practice come in for most
criticism...”
John Maynard Keynes (1936)
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 Long-Term Advantages
• Slight predictability …. via mean reversion

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 Mean Reversion in Action
US Stock Values Are Mean Reverting.
log scale
100

If returns were random, over different horizons, they

Real value of $1 invested at start of
period, with reinvested dividends.

should lie in this range 90% of the time.

10

Because they are mean reverting they have

stayed within this far narrower range
0
0 5 10 15 20 25 30
Number of Years You Stay in Stocks.
Smithers & Co. Ltd.
 Long-Term Advantages
• Slight predictability …. via mean reversion

• Lower Risk?
- Matches intentions horizon
- Depends; annualised volatility , but …

• Lower turnover  lower (certain) costs

• Minimal competition  limited arbitrage

• Alternatives; Sustainability?

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Return of the 2-Armed Economist

“…it is not wise to look too far ahead; our

powers of prediction are slight, our
command over results infinitesimal …”

Yup, that guy Keynes again

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 “Powers of Prediction Are Slight”

14%

S&P 500 dividend yield

12%
10yr US Govt bond yield

10%

8%

6%

4%

2%

0%
1871 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001

Source:: Global Financial Data End May 2009

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We’re Not Just Homo Economicus
“An exclusive concern with the long-term may be
prescriptively sterile, because the long-term is not
where life is lived. Utility cannot be divorced from
emotion …

A theory of choice that completely ignores feelings

such as the pain of losses and the regret of mistakes is
not only descriptively unrealistic, it also leads to
prescriptions that do not maximise the utility of
outcomes as they are actually experienced…”

Danny Kahneman
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The Enemy Is Us

Source: CIAweb site

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 5 Steps to Long-Termism
1. Recognise/struggle against barriers:
- Cognitive: Re-read the masters
- Temperament/Affect: Training?
- Institutional: Incentives matter

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 5 Steps to Long-Termism
1. Recognise/struggle against barriers:
- Cognitive: Re-read the masters
- Temperament/Affect: Training?
- Institutional: Incentives matter

2. Use anchors of long-term value-added:

- Slight predictability
- Human psychology (individual & group)
- Rhythms of history
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 5 Steps to Long-Termism

3. Be selectively sensitive to the short-term

but avoid Gresham’s Law of Investing:

“Comforting short-term, urgent drivel

drives out discomforting, long-term
important information”

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Drivel, Drivel Everywhere Nor
Any Time to Think…

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 5 Steps to Long-Termism
3. Be selectively sensitive to the short-term
but avoid Gresham’s Law of Investing:

“Comforting short-term, urgent drivel drives

out discomforting, long-term important
information”

“All man’s miseries derive from being

unable to sit quietly in a room alone.”

Blaise Pascal, c.1630

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 Thoughtful Inertia

Don’t just do something … sit there.

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 5 Steps to Long-Termism

4. Develop strategic partnerships with

managers, consultants, funds
- Kultur is Kritical
- Mandate flexibility
* 10-year mandates; Closed-end funds
* Well-structured PBF
* Question turnover and agency effects

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 5 Steps to Long-Termism
5. Develop and use Investment Beliefs
including a Long-Term Investment
Statement:
- Charter of decision-making
- Estimates of risk-tolerance (relative,
absolute, liquidity, ..)
- Tolerance for explicable underperformance
- Exposure to long-duration alternatives
- Emphasis on sustainability
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So How Long is The Long-Term?

Depends on …

• Liabilities
• Assets
• Markets
• Risk(s) tolerance
• Temperament
• Career/business

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So How Long is The Long-Term?

• Pragmatic Advice: Push clients a bit

beyond their comfort horizon

• When pushed for an answer try ….

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So How Long is The Long-Term?

• Pragmatic Advice: Push clients a bit

beyond their comfort zone.

• When pushed for an answer try ….

Seven Years

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 Avoiding Short-Termism (Fin)
• Excessive short-termism is a sin

• All participants bear some guilt

• Long-termism has some benefits

• Learn to exploit the long-term

• Have courage and wisdom

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 Disclosure
This presentation is intended to provide information of a
general nature and does not take into account investors’
particular needs, objectives or circumstances.
Before acting on this information, investors should consider
its appropriateness having regard to their own situation.
To the extent permitted by law, no liability is accepted for
any loss or damage that results from reliance on this
information.
While due care has been taken in preparing the presentation,
no warranty is given as to its accuracy or completeness.

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