Does pragmatism undermine long-term investment?

Long-term companies provide superior financial returns, better fundamentals and a more positive impact on the economy and society. Fund managers, in turn, need to take a longer view, exploit the outperformance offered by long-term firms for the benefit of their clients, and encourage more corporates to think long-term.

A few days ago I was chatting to a fund manager at one of the biggest UK fund houses. There was gin involved so I can’t recount the whole conversation word for word, but he did say something that stands out. We were talking about the need for long-term investors to consider the wider implications of their allocation decisions and think long-term – or at least this was what I was banging on about – when he said: “I see a 20 year investment horizon as a collection of 4-5 year investment horizons. There is what we ‘should’ do, and then there is being pragmatic.”

This got me to thinking: Does pragmatism force investors to take a short-term view?

Not according to the McKinsey Global Institute. Their report Measuring the Economic Impact of Short-Termism, issued a day after my conversation with this fund manager, summarised the findings of their research thus: “Our new Corporate Horizon Index provides systematic evidence that a long-term approach can lead to superior performance for revenue and earnings, investment, market capitalization, and job creation.”
 
The report rolls from one finding in support of long-termism to another: long-term firms exhibit stronger fundamentals, growing their revenue cumulatively 47% more on average than other companies and in a less volatile manner, allowing them to weather the financial crisis better; they continue to invest in difficult times, spending significantly more on R&D, which helps them maintain consistent and sustainable sources of growth - key goals of long-term planning (see charts below).

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Long-termism outperforms
Among the most compelling findings is that long-term companies deliver superior financial performance. They added $7 billion more in market capitalisation on average than other firms between 2001 and 2014. According to the report: “If all other firms had appreciated at the same rate as long-term firms, US public equity markets could have added more than $1 trillion in incremental asset value from 2001 to 2014, increasing total US market capitalization by roughly 4 percent. This forgone value would have been enough to eliminate a substantial portion of the total funding gap among US public pensions that are among the largest shareholders of these companies.”

Longer-term firms also delivered better total returns to shareholders and were 50% more likely to be in the top decile and top quartile of shareholder returns for their industries, and 10% less likely to produce returns below the industry median. “Long-term companies representing 27 percent of the total sample capture a disproportionate 44 percent of the growth in total returns to shareholders from 2001-2014,” MGI’s report says.

Short-termism is contagious
So clearly, long-term companies offer a far better option to shareholders and the clients of fund managers than other companies. This is of great benefit to pension funds and the savers whose money they contain.

However, if fund managers continue to place a short-term focus on how they run portfolios, how can we possibly reverse the increasing pressure corporate executives feel to think short-term? Short-termism is highly contagious, after all.

I would go a step further in this and suggest that, if short-termism is value destructive, fund managers have a clear fiduciary duty to favour long-term companies and to take a long-term approach to how they manage their portfolios.

Short-termism fuels inequality
But the benefits to savers of long-term companies doesn’t just stop with the returns to their savings.

The MGI report also found long-term companies add more to economic output and growth, hiring millions of workers. According to the report, between 2001 and 2015, long-term companies added more jobs to the economy that other firms, and did so in an increasingly disproportionate manner in the lead up to the financial crisis and in the period since. (see chart below: Average job creation)

This links short-termism directly to inequality and the populist movement it caused.

As the body of evidence in favour of long-term thinking continues to mount, surely fund managers cannot ignore the detrimental effects of short-term thinking? It directly undermines long-term savers’ ultimate goals by hindering the financial returns they enjoy, and the wider societal and economic conditions they will live and retire in.

So I would argue, no, pragmatism doesn’t force investors to take a short-term view. Quite the opposite.

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​The best ideas are born of collaboration, debate and discussion. If you agree or disagree with any of the arguments above, or want to expand on the topic, please add a comment below.

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