Get off the merry-go-round

Short termism: Get off the merry-go-round

Seek long-term benefits 

Long-term investing is under attack. Fund managers and financial advisers constantly receive ‘hot investment tips’ and are pressured to regularly turn-over their portfolios.

In the United States, the average holding period for US shares has fallen from seven years in the mid-1980s to around seven months today. 

Research conducted by SCM Private found that UK pension funds had an average portfolio turnover of 128% per annum, adding 0.7% in undisclosed costs. The cumulative effect of this over 20 years results in a 15% reduction in retirement savings.

Corporates are behind the rise of short termism. A great example of this development is IBM. In 1973, the group’s mission centred on respect for employees, commitment to customer service and achieving excellence. By the early 1990s this changed to “our primary measures of success are customer satisfaction and shareholder value” and in 2010, the company aimed to double earnings per share (EPS) over the next five years. To this day, there’s no mention of long term values, staff or community development.

This is in stark contrast to Johnson & Johnson which has had the same customer-focused mission statement since 1943. Their long term ethos has been maintained throughout history which is reflected in the growth of their business. 

IBM v Johnson & Johnson 

Johnson & Johnson’s customer-centric approach is rare and corporates increasingly focus on shareholder value alone.

Executives are not incentivised to achieve long-term business goals but rather pursue short-term EPS targets. One way management are continually earning their bonus despite falls in revenue or sales is through share buy backs, which have become common practice. 

A share buyback occurs when a company purchases or retires some of its outstanding shares. This can be great for shareholders as they will own a greater portion of the company and therefore its earnings. However, don’t be fooled. Buy backs boost the EPS of a company as earnings are distributed among fewer shares giving the illusion of an increase in value. The company now has less cash from purchasing the shares which offsets the increase in EPS leaving zero net change for investors while the management earn their bonus. 

Last year in the United States, CEOs were paid 303 times that of workers in their respective industries, compared with 59 times in 1989.

To compound this issue, the average tenure of a CEO has fallen sharply from twelve years in the 1970s to just six years today. This further incentivises CEOs to meet their annual bonus targets at the cost of shareholders as they have a minimum allowable period to do so.

But investors aren’t innocent when it comes to short termism.

Corporates argue that they are compelled to achieve quarterly results or shareholders will sell their shares. 

So how can we avoid this perpetuating the cycle? 

At ClearView, we aim to invest in managers with a long-term view.

For example, the Stewart Investors Worldwide Sustainability Fund – which invests in companies characterised by long-term alignment between management and minority shareholders – has recently been incorporated into our implemented model portfolios. 

Stewart Investors seeks to invest in companies with a long-term sense of purpose and a clear set of values.

The ‘sustainable’ element of their process is not ‘green’ or ‘ethical’ underpinned by thematic trends such as clean energy. Instead Stewart Investor’s seek companies that are well-positioned to contribute to and benefit from the sustainable development of the countries they operate within, having high conviction that such companies face fewer risks and are better placed to deliver positive long-term risk-adjusted returns to shareholders. 

For instance, the largest weight within their portfolio is allocated to Unilever who has delivered just under 13% p.a. over the past decade in contrast to just over 5% p.a. from the FTSE100 index. They achieved this through strengthening the agricultural practices of 600,000 farmers in its supply chains making them more resilient and efficient, and decreased the water intensity of its factories by 40% reducing costs and increasing margins. By making these investment choices, Unilever deferred some of today’s profits in order to realise greater gains tomorrow. 

The recent SnapChat IPO with no voting shares is a worrying trend of companies that do not align their interests with investors and have no incentives for management to deliver long term sustainable growth.

Loyalty should be maintained but only for firms that are pursuing long term value. A good active manager such as Stewart Investors can assist in consistently investing in firms pursuing long term value for the right price.

Jessica Schlosser is an investment analyst at ClearView.