Avoiding Short-Termism in Investment Decision-Making Jack Gray

Transcription

1 Avoiding Short-Termism in Investment Decision-Making Jack Gray Co-Director Asset Allocation GMO September 2007 GMO

2 Important Information The information in this presentation is of a general nature only and is not financial advice. The information does not take into account any individual s objectives, circumstances or needs. Appropriate advice should be sought before making any investment decision. Past performance is no indication of future performance. While reasonable care has been taken in preparing this information, neither GMO Australia Limited, Grantham, Mayo, Van Otterloo & Co. LLC, nor any of their affiliates or related bodies corporate provides any warranty of accuracy in relation to such information or accepts any responsibility or liability for any reliance on it. This information does not constitute an offer or solicitation of any security or an offer to invest in any financial product. The offer to invest in any GMO financial product is contained in the relevant information memorandum or other offering document and is subject to the conditions set out therein. GMO Australia Limited ABN , Australian Financial Services Licence

3 Agenda Excessive short-termism is a sin Where does short-termism develop? All participants bear some guilt Long-termism has some benefits and advantages 5 steps to getting to and exploiting the longterm 3

4 Short-Termism Can Be Costly 4

5 Costly Indeed a swelling interest in investment performance has created an increasingly short-term oriented and more speculative market. Warren Buffett 5

6 Costly Indeed a swelling interest in investment performance has created an increasingly short-term oriented and more speculative market. Warren Buffett (1969) 6

7 Long-Term Takes the Moral High-Ground 7

8 Long-Termism Can Be Costly 8

9 Costly Indeed Neither a panacea for investment virtue - VHF hedge funds - 25 vs 75 year-old Nor a paragon of investment virtue - Disposition effect - DB policy mix 9

10 Excessive Short-Termism Is a Problem Distortion of opportunities, eg, Momentum Private Gain, Public Cost 10

11 Correlated, Yet Huge Swings EAFE ex Japan vs. S&P 500 Cumulative Relative Wealth in U.S. $ Terms S&P +58% Currency +10% EAFE ex Japan +71% Currency +21% S&P +96% Currency +76% EAFE ex Japan +76% Currency +50% S&P +80% Currency +25% EAFE ex Japan +53% Currency +34% 0.6 Correlations: May Source: GMO, Standard & Poors. As of 6/30/06

12 Excessive Short-Termism Is a Problem Distortion of opportunities, eg, Momentum Private Gain, Public Cost Churning destroys wealth Substantial value permanently destroyed/transferred in extremes 12

13 Ever Shorter Short-Termism 13

14 No Contest: Turnover vs. Returns 942 US Equity Mutual Funds: 10 Years to Feb % 160% 140% 120% 100% 80% 60% 40% 20% 0% MER: Turnover (LHS) Pre-tax Returns (RHS) 1.0% 1.1% 1.3% 1.3% 12.0% 11.5% 11.0% 10.5% 10.0% 9.5% 9.0% 8.5% Source: Bogle

15 Churn, Baby, Churn Value Chain: Market Fund Investor US Equity Mutual Fund Annual Returns % 77% of Market 12% 10% 48% of Market Return 8% 6% 4% 2% 0% Market Fund Investor 15 Source: Bogle

16 Short-Term Valuation bn Profits Dividends Sales Assets MCap Vodafone Food Retailers Real Estate Gas Distribution Alcoholic Beverages Chemicals Tobacco Water Construction & Building Materials Healthcare Engineering Vehicles Diversified Industrials Distributors Print, Paper & Packaging Household Goods Oil Exploration & Production companies in 15 sectors for the price of Vodafone 16 As at 31/03/00; Source: GMO

17 Value Destruction/Transfer Vodafone M arket Cap Invested 129 for AirTouch acquisition and 307 for Mannesmann acquisition Total passive investment 536 Value at July For every initial investment of 100 Dec-98 Jun-99 Dec-99 Jun-00 Dec-00 Jun-01 17

18 We re All Guilty Scurrilous Survey (2004) Player Media Government/Regulators Financial Planners Consultants Members Trustees/Fiduciaries Investment Managers Corporations/Analysts Guilty of Short-Termism? 89% 81% 81% 68% 64% 53% 27% N/A 18

19 So Is Long-Termism Virtuous?... to make the purchase of an investment permanent might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only. it is the long-term investor, he who most promotes the public interest, who will in practice come in for most criticism... John Maynard Keynes (1936) 19

20 Long-Term Advantages Slight predictability. via mean reversion 20

21 Mean Reversion in Action log scale US Stock Values Are Mean Reverting. 100 Real value of $1 invested at start of period, with reinvested dividends If returns were random, over different horizons, they should lie in this range 90% of the time. Because they are mean reverting they have stayed within this far narrower range Number of Years You Stay in Stocks. Smithers & Co. Ltd.

22 Long-Term Advantages Slight predictability. via mean reversion Lower Risk? - Matches intentions horizon - Depends; annualised volatility, but Lower turnover lower (certain) costs Minimal competition limited arbitrage Alternatives; Sustainability? 22

23 Return of the 2-Armed Economist it is not wise to look too far ahead; our powers of prediction are slight, our command over results infinitesimal Yup, that guy Keynes again 23

24 Powers of Prediction Are Slight... 14% 14% 12% 12% 10% 10% 10% 8% 8% 8% 6% 6% 6% 4% 4% 4% 2% S&P 500 dividend yield S&P 500 dividend yield 10yr US Govt bond yield 10yr US Govt bond yield 2% 2% 0% % 0% Source: Global Financial Data

25 10y Real Return Slightly Predicted by Q 15% Starting value of Tobin's Q 10% 5% 0% -5% over to to to to

26 But Can You Wait This Long? Price/Replacement Cost Source: Smithers & Co., Federal Reserve. As of 12/31/04

27 We re Not Just Homo Economicus An exclusive concern with the long-term may be prescriptively sterile, because the long-term is not where life is lived. Utility cannot be divorced from emotion A theory of choice that completely ignores feelings such as the pain of losses and the regret of mistakes is not only descriptively unrealistic, it also leads to prescriptions that do not maximise the utility of outcomes as they are actually experienced Danny Kahneman 27

28 The Enemy Is Us 28 Source: CIAweb site

29 5 Steps to Long-Termism 1. Recognise/struggle against barriers: - Cognitive: Re-read the masters - Temperament/Affect: Training? - Institutional: Incentives matter 29

30 5 Steps to Long-Termism 1. Recognise/struggle against barriers: - Cognitive: Re-read the masters - Temperament/Affect: Training? - Institutional: Incentives matter 2. Use anchors of long-term value-added: - Slight predictability - Human psychology (individual & group) - Rhythms of history 30

31 5 Steps to Long-Termism 3. Be selectively sensitive to the short-term but avoid Gresham s Law of Investing: Comforting short-term, urgent drivel drives out discomforting, long-term important information 31

32 Drivel, Drivel Everywhere Nor Any Time to Think 32

33 5 Steps to Long-Termism 3. Be selectively sensitive to the short-term but avoid Gresham s Law of Investing: Comforting short-term, urgent drivel drives out discomforting, long-term important information All man s miseries derive from being unable to sit quietly in a room alone. Blaise Pascal, c

34 Thoughtful Inertia 34

35 5 Steps to Long-Termism 4.Develop strategic partnerships with managers, consultants, funds - Kultur is Kritical - Mandate flexibility * 10-year mandates; Closed-end funds * Well-structured PBF * Question turnover and agency effects 35

36 5 Steps to Long-Termism 5.Develop and use Investment Beliefs including a Long-Term Investment Statement: - Charter of decision-making - Estimates of risk-tolerance (relative, absolute, liquidity,..) - Tolerance for explicable underperformance - Exposure to long-duration alternatives - Emphasis on sustainability 36

37 Avoiding Short-Termism (Fin) Excessive short-termism is a sin All participants bear some guilt Long-termism has some benefits Learn to exploit the long-term Have courage and wisdom 37

38 Contact Information (optional) Jack Gray Co-director Asset Allocation GMO