Avoiding Short Termism by Jack Gray

8/9/2019 Avoiding Short Termism by Jack Gray

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Avoiding Short-Termism inI nvestment Decision-Making

Jack Gray

Centre for Capital Market Dysfunctionality, UTSRawson East P/L

Brookvine P/L

CFA Seminar

April 2010


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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


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Short-Termism Can Be Costly


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Costly Indeed

a swelling interest in investmentperformance has created anincreasingly short-term oriented and more speculative market.

Warren Buffett


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Costly Indeed

a swelling interest in investmentperformance has created anincreasingly short-term oriented and more speculative market.

Warren Buffett (1969)


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Long-Term Takes the MoralHigh-Ground


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Long-Termism Can Be Costly


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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


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E x c e s s i v e Short-Termism I s aProblem

Distortion of opportunities:* Momentum Private Gain, Public Cost * Correlation: Qrt, Mo, Wk, Dy, ,Sec,


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Short-Term Valuation

Gas DistributionReal Estate

Construction & Building MaterialsHealthcare

Engineering Vehicles

DistributorsDiversified Industrials

TobaccoChemicals

Alcoholic Beverages

Water

Print, Paper & Packaging

Oil Exploration & ProductionHousehold Goods

Food Retailers

213

0.9

Dividends

8.4

1.3

Profits

12.7 250.6 99.2

6.7 1.0

Sales Assetsbn MCap

214Vodafone

343 companies in 15 sectors for the price of Vodafone

As at 31/03/00; Source: GMO

10 9 37 99


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Correlated, Yet Huge Sw ingsEAFE ex Japan vs. S&P 500

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

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

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

C u m u

l a t i v e

R e l a t

i v e

W e a

l t h i n U

. S .

$ T e r m s

May-

S&P+58%

Currency+10%

S&P+96%

Currency+76%

EAFEex Japan

+76%Currency

+50%

S&P+80%

Currency+25%

EAFEex Japan

+53%Currency

+34%

0.67 0.22 0.55 0.44 0.61 0.86Correlations:

EAFEex Japan

+71%Currency

+21%


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E x c e s s i v e Short-Termism I s aProblem

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 v s Returns942 US Equity Mutual Funds: 10 Years to Feb 2005

0%

20%

40%

60%

80%

100%120%

140%

160%

180%

1.0% 1.1% 1.3% 1.3%8.5%

9.0%

9.5%

10.0%

10.5%

11.0%

11.5%

12.0%

Turnover (LHS)

Pre-tax Returns (RHS)

MER:

Source: Bogle


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Churn, Baby, Churn

Source: Bogle

Value Chain: Market Fund Investor

0%

2%

4%

6%

8%

10%

12%

14%

Market Fund Investor

US Equity Mutual Fund Annual Returns 19832003

77% of Market

48% of Market

Return


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W ere All GuiltyScurrilous 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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... to make the purchase of an investment

permanent might be a useful remedy forour contemporary evils. For this wouldforce the investor to direct his mind to the

long-term prospects and to those only. it is the long-term investor, he whomost promotes the public interest, whowill in practice come in for mostcriticism...

John Maynard Keynes ( 1936)

So Is Long-Termism Virtuous?


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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.

0

1

10

100

Number of Years You Stay in Stocks.

Smithers & Co. Ltd.

R e a l v a

l u e o

f $ 1 i n v e s

t e d a

t s t a r t o

f

p e r

i o d

, w

i t h r e

i n v e s t e d

d i v i d e n

d s .

log scale

5 15 2510 20 300

If returns were random, over different horizons, theyshould lie in this range 90% of the time.

Because they are mean reverting they havestayed within this far narrower range


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Long-Term Advantages

Slight predictability . via m ean 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; ourpowers of prediction are slight, ourcommand over results infinitesimal

Yup, that guy Keynes again


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0%

2%

4%

6%

8%

10%

12%

14%

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

S&P 500 dividend yield

10yr US Govt bond yield

P ow ers of Prediction Are Slight

Source:: Global Financial Data End May 2009


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W ere Not Just Ho m o Eco n o m i cu s

An exclusive concern with the long-term may beprescriptively sterile, because the long-term is notwhere life is lived. Utility cannot be divorced fromemotion

A theory of choice that completely ignores feelingssuch as the pain of losses and the regret of mistakes isnot only descriptively unrealistic, it also leads to

prescriptions that do not maximise the utility ofoutcomes as they are actually experienced

Danny Kahneman


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The Enemy I s 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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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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3. Be selectively sensitive to the short-termbut avoid Greshams Law of Investing:

Comforting short-term, urgent driveldrives out discomforting , long-termimportant information


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Drivel, Drivel Everyw here NorAny Time to Think


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3. Be selectively sensitive to the short-termbut avoid Greshams Law of Investing:

Comforting short-term, urgent drivel drives

out discomforting , long-term importantinformation

All mans miseries derive from beingunable to sit quietly in a room alone.

Blaise Pascal, c.1630


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Thoughtful Inertia

Dont just do something sit there.


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4. Develop strategic partnerships withmanagers, 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. Develop and use Investment Beliefsincluding a Long-Term InvestmentStatement :

- 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 i s The Long-Term?

Depends on

Liabilities

Assets Markets Risk(s) tolerance

Temperament Career/business


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Pragmatic Advice: Push clients a bit beyond their comfort horizon

When pushed for an answer try .


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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 ( Fi n )

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 ageneral nature and does not take into account investorsparticular needs, objectives or circumstances.

Before acting on this information, investors should considerits appropriateness having regard to their own situation.

To the extent permitted by law, no liability is accepted forany 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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Avoiding Short Termism by Jack Gray