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Taking the long term view

March 22, 2013
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As every investor knows - or ought to - it’s best to invest for the long term.

Yet all too often we do precisely the opposite. We take fright and move away from equities when sentiment turns bearish, then pile in when optimism returns. We’re human, sensitive and ever anxious to do the right thing. So we do the wrong thing - and over-trade - stressing ourselves out and, over time, costing ourselves a small fortune in charges. 

Ah, we hear you say. I don’t have to worry about that. I’ve chosen a fund manager (more likely, in fact, a number of managers) to manage my investments for me. If anyone knows about the importance of a long-term horizon, you say, surely it’s the professionals. 

Of course they know it, yes. But fund managers are even more likely than we are to think short-term. After all, their bonus system is based on their performance over, say, three, six or 12 months - on how they manage to achieve a bigger return than their rivals when markets go up, and limit the damage when markets fall.

Hence, momentum investing - in simple terms, buying shares that are on a winning streak, and dumping those whose price is falling - has become the dominant strategy. Managers who take an alternative approach, known as fundamental analysis - in other words, those who buy shares based purely on expected future earnings and wait patiently for prices to recover from the undershooting caused by momentum - risk losing their bonuses and, ultimately, their jobs. 

The good news is that politicians and other influential figures have started to acknowledge this mismatch between what’s best for investors - and what the investment industry is actually providing them with. 

MPs are considering the findings of a government-backed review by John Kay, Professor of Economics at the LSE, who’s warned that “short-termism” isn’t just damaging for investors, but for the UK economy. The European Union is due to release a Green Paper on long-term investing, and the G30 - an international body set up in an attempt to prevent a recurrence of the financial meltdown of 2008 - has just published a paper with specific recommendations. 

Two other LSE economists - Paul Woolley and Dimitri Vayanos - recently suggested in the FT some ideas for inclusion in a “long-term investing code”. For example, they want to see the scrapping of fees for short-term performance, and a cap on fund turnover of 30%. 

We of course welcome the fact that this critical issue for investors is now being discussed at the highest level. We’ve always said that the investment industry operates primarily in the interests of itself - not the investor - and that has to change. 

However we are sceptical about the appetite in the UK government in particular to insist on reforms that, by and large, will not be welcomed in the City. We are also realistic about the speed with which this largely self-regulated industry will be willing to mend its ways. 

In the meantime, it’s up to individual investors to set their own time horizons. After all, they don’t have to worry about meeting short-term targets to earn their bonuses. What investors want, more than anything, is peace of mind that they genuinely are doing the right thing. 

Sticking through thick and thin with a simple, low-cost, diversified portfolio, that’s rebalanced either once or twice a year, really is the best way of ensuring long-term investment success.

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