subject: Secrets Of Success: The long and the short of investments posted: Sat, 24 Jun 2006 15:29:59 +0100
[lotsa goodies in this one, including a citation for the assertion
that the stockmarket outperforms a bank account, on average over a
ten year period. - Stu]
Secrets Of Success: The long and the short of investments
By Jonathan Davis
Published: 24 June 2006
What is your real-time horizon as an investor? If you are a hedge
fund manager, you must think and act on a daily - sometimes hourly -
basis. If you are a unit trust manager, with a mandate geared towards
beating the market rather than generating absolute returns, you will
turn over your portfolio once every 12 to 18 months.
If you are a pension fund manager, your time horizon is about the
same as your average liability structure, which is around eight to 12
years. For some endowments - say a well-funded Oxford college that
has no plans to go out of business in the next few hundred years -
the time horizon can, in effect, be forever.
Logic suggests that in each of these cases, the investment strategy
you adopt should be appropriate to your objective and time horizon.
That, in practice - though far from perfect - is what happens.
There are discernible differences in the way that hedge funds and
endowments, say, manage their assets. The mix of assets they own and
the rate at which those portfolios are turned over vary enormously.
There can be big differences, too, in the extent to which different
types of investor rely on generating income from their assets.
For individual investors, the same differences apply. Those who rely
on their investments to generate an income are often driven towards a
strategy that forfeits some degree of long-term capital return in
order to meet their annual requirements. In the case of those who are
merely looking to save for some uncertain future eventuality, the
urge to change portfolios is much smaller. That has advantages and
disadvantages, depending in part on whether the management of your
portfolio has been delegated or not.
For those who take their own decisions, changing a portfolio too
often can be costly. If professional investors cannot, on average,
beat the market over time, the odds that know-little individuals will
be able to do so are well below 50 per cent, and probably as little
as one-in-10.
A passive investment strategy, diversified across property, bonds and
shares, and implemented at low cost, is the obvious, optimal solution
in these cases.
In effect, you are giving up the small chance of outperforming the
market in return for the certainty of not doing materially worse than
the average. In turn, a passive strategy has the effect of
lengthening your time horizon as an investor and minimising your
annual holding cost - two positives.
Delegating your choice of strategy and trading decisions to someone
with the professional knowledge can be a viable alternative if you
are lucky or smart enough to find the right person or organisation to
delegate that work to. But there are two main problems to consider.
One is that seeking professional help is expensive; the risk is that
what you gain from the help is offset by the cost of execution. The
second is that there may be agency issues between you and the
professional; that the interests of brokers and clients are not
aligned - the former having a vested interest in much higher rates of
turnover than is optimal for the latter. Commission-driven advisers
suffer the same disadvantage.
Jack Bogle, the founder of Vanguard, makes a distinction between what
he calls the investment profession and the investment business. The
former is characterised by a commitment to deliver superior long-term
returns for clients. It tends to produce an investment approach that
is patient, long term and contrarian. The investment business is
primarily driven by the need to generate fees and maximise the
earnings of the investment firm. The investment approach tends to be
much more active and costly.
There is much evidence that if you are going to delegate, you should
look for those who operate on the specialist professional model. The
narrower the range of funds that a firm offers, the better on average
its performance.
Privately owned firms, on average, produce much better results than
large, publicly quoted companies, where the need to sustain year-on-
year earnings growth - and the scope for conflicts of interest - is
much greater. The corresponding risk is that professional firms may
be over-reliant on particular individuals.
The good news, says Michael Mauboussin, the strategist at Legg Mason,
is that so many players in the markets today are driven primarily by
short-term considerations that it is creating opportunities for those
who operate on a longer-term horizon.
While hedge funds are the most extreme example of a short-term
approach, performance-chasing unit trusts and Oeics, and pension
funds that dance to a regulator's tune rather than long-term
investment considerations, are contributing to the phenomenon.
The bad news is that individual investors seem oblivious to this
opportunity. The data on stock and fund flows suggests that most of
us continue to push money into those sectors that are hot or have the
best short-term track record rather than into investments that can be
plausibly justified as being cheap on a longer-term perspective. The
investment industry, with its focus on sales, has no interest in
stemming this trend.
If you are operating with a long-term investment horizon, it makes
sense to judge your results on the same timescale. It may be no
accident that it is still pretty difficult, say, to find 10-year
performance histories on fund websites.
By a neat coincidence, as of the end of May, the 10-year performance
figures show that the stock market has returned a compound 8.3 per
cent a year, which, allowing for inflation at say 2.5 per cent, is
remarkably close to its long-term real return of 6.5 per cent a year.
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