Michael Mauboussin is considered an expert in the field of behavioral finance and has some famous books on the topic including, Think Twice: Harnessing the Power of Counterintuition and More More Than You Know: Finding Financial Wisdom in Unconventional Places, see his latest piece from Credit Suisse below.
Michael Mauboussin: A Long Look at Short-Termism – Questioning the Premise H/T Tren Griffin
“The . . . specific task of managers is to harmonize in every decision and action the requirements of the immediate and long-range future. Managers cannot sacrifice either without endangering the enterprise.”
Peter F. Drucker
- Short-termism is said to plague all parties in the investment community, including investment managers, companies, and investors. However, it is very difficult to prove.
- To assess and evaluate the impact of market short-termism, the right level of analysis is not what individuals say but rather what the stock market does.
- For many companies, a contraction in time horizon is a proper response to economic reality.
- Corporate executives and investors who suffer from short-termism are partners in a dance who are attracted to one another based on their characteristics.
- The holding period that is relevant in portfolio construction is the time an investor is exposed to an asset class, not the turnover for a particular stock or fund.
- We provide specific recommendations to deal with the pressures of short- termism for investment managers, companies, and investors.
“Short-termism” is widely accepted as a major problem in the investment industry. Short-termism is the tendency to make decisions that appear beneficial in the short term at the expense of decisions that have a higher payoff in the long term. For example, a company exhibits short-termism when it cuts its research and development budget to deliver higher earnings this year, forsaking larger profits in the future. Likewise, an investor who forgoes a stock that trades at a steep discount to intrinsic value to buy a stock based on an anticipated near-term price move engages in short-termism.
Short-termism is said to plague all parties in the investment community, including investment managers, companies, and investors. The typical story is that investors demand short-term results, forcing investment managers to dwell on immediate gains, which ultimately spur investment managers to press companies for quarterly results. Short-termism has caused a great deal of hand-wringing.1
The problem is that short-termism is very difficult to prove. As we will see, many of the common perceived symptoms of short-termism don’t hold up to scrutiny, and there are some legitimate reasons for the shortening of time horizons. While there remains plenty of room for improvement, especially when it comes to incentives, the issue of short-termism deserves more care than it has received in the popular discourse. With little exception, the debate appears to be very one-sided.2
A quote from a recent article by Dominic Barton, a consultant at McKinsey & Company, and Mark Wiseman, president and chief executive officer (CEO) of the Canada Pension Plan Investment Board, captures the prevailing mood:
“. . . the shadow of short-termism has continued to advance—and the situation may actually be getting worse. As a result, companies are less able to invest and build value for the long term, undermining broad economic growth and lowering returns on investment for savers.
The main source of the problem, we believe, is the continuing pressure on public companies from financial markets to maximize short-term results.”3
While the discussion of short-termism has gone from a mild simmer to a rolling boil following the financial crisis, concerns about short-termism have been around for a long time. Consider the following quotations:
“The average holding period of stocks has declined from over seven years in 1960 to about two years today. This decline implies a dramatic shift in the frequency with which investors buy and sell
corporate equities. It is perhaps the most telling evidence of shortening investor horizons.” – Michael E. Porter (1992)4
“Given the large buying power of their institutions, there is an obvious risk that speculative in-and-outtrading of this type may virtually corner the market in individual stocks. And in any event, activity of this kind tends to create undesirably volatile price fluctuations. I find this trend disquieting. However laudable the intent may be, it seems to me that practices of this nature contain poisonous qualities.”
– William McChesney Martin (1967)5
“For most of [the professional investors and speculators] are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. They are concerned, not with what an investment is really worth to a man who buys it ‘for keeps,’ but with what the market will value it at, under the influence of mass psychology, three months or a year hence.” – John Maynard Keynes (1935)6