Since You Asked

Patience pays off for long-game investors

Stockpickers who persevere with their ‘pets’ are rewarded when they perform impressive profits

“Neil Woodford, one of the colossi of British fund management, is leaving Invesco Perpetual after a quarter of a century to pursue his conviction that modern investment has become too short-term.”, Financial Times, October 15

One of the colossi?

I know, I know. I’d have plumped for one of the colossoi myself. Or one of the colossuses. Or maybe one of the giants.

I wasn’t being pedantic. I was wondering whether there really are any colossi in stockpicking. Wasn’t the Nobel Prize in economics given this week to Eugene Fama, who showed you can’t beat the market?

Speaking of pedantry, it’s not a Nobel Prize. It’s best described as the Nobel Memorial Prize. And, yes, Professor Fama did show you can’t beat the market. But whether or not he’s correct, investors believe in star stockpickers, from Benjamin Graham and Warren Buffett to Anthony Bolton and Mr Woodford. So there’s likely to be a stampede for the exit at Invesco Perpetual, which could be hard to manage.

Do you think Mr Woodford is merely the beneficiary of a lucky streak, then?

It’s devilishly hard to know. His record is excellent – over the past 25 years, the market as a whole would have turned £100 into £1,000; Mr Woodford would have turned it into £2,300. A modest degree of outperformance, delivered with reasonable consistency over a quarter of a century, will do that to your portfolio. Maybe those results are a matter of luck – there are, after all, many fund managers in the world, and somebody has to be the best. But maybe it’s real skill. Quite possibly both. One of Prof Fama’s findings was that smaller companies, with low market value relative to book value, have tended to outperform the market as a whole. This may be because such companies are riskier and the high expected return is compensation for taking that risk. It turns out that such companies have played a significant part in Mr Woodford’s success.

It might also be that he takes an interest in the companies he invests in.

He’s certainly had substantial shares in some of them for a very long time. This is similar to Warren Buffett’s approach, and is reminiscent of John Maynard Keynes’ behaviour while investing on behalf of King’s College, Cambridge. Keynes invested for the long term in a few favoured companies, which he called his “pets”. These were extremely profitable – in contrast to the investments he made earlier in his career, when he tried to deploy his knowledge of the business cycle to time his trades.

Timing the market didn’t work out for him?

No. Buffett-style value investing did very well, though.

But this long-term vision isn’t just an investment strategy, is it? There’s a sense that stock markets are insanely short-termist these days, and Mr Woodford’s activist approach and “buy-and-hold” tactics are good for capitalism as a whole.

It’s curious. One of the points of an equity market is that, by making shares easy to trade, it allows investors to take a long-term view of profits. As a shareholder in a non-traded company, you care about when it makes its money because it directly affects your own cash flow. But if you hold shares in a publicly traded company then you don’t need to worry about the precise timing of profits: you can cash out at any time by selling to someone who is able to wait.

I understand the theory but things are different in practice, aren’t they?

It seems so. John Kay, an FT columnist who chaired a government-commissioned review into equity markets, felt many British companies were too focused on short-term returns. The reason for that was the behaviour of Mr Woodford’s competitors and all the other intermediaries that stand between company managers on one side and savers and pensioners on the other.

But Mr Woodford has directly benefited from a long-term perspective – as did Mr Buffett and Keynes. Why don’t other investment managers acquire a few “pets”, if it’s so good for business?

That’s a good question. We are unwittingly rewarding investment managers for sticking with the crowd and following some particular benchmark. More independent-minded managers are taking a big risk – if their decisions don’t pay off at first, they are unlikely to get another chance. Even Mr Woodford has had bad years: if they had come early in his career, I wouldn’t now be talking about him.

Also published at ft.com.

19th of October, 2013Since You Asked • Comments off