A quirky study backs long-term buy and hold.
A paper just published by Andrew Haldane, the Bank of England's executive director for financial stability, will contain few surprises for long-term readers of The Fool.
But despite the familiarity of its underlying message, it's also one of the more thought-provoking things that I've read this summer. Rich in behavioural finance and empirical evidence, and drawing in anecdotes from the worlds of football, dieting, drug addiction and fitness clubs, the paper deserves a wider readership than it is sadly likely to get.
As Mr Haldane puts it: "This paper brings together lessons from economics, history, psychology, neurology, sociology to assess patience and its implications for the evolution of economic and financial systems."
In short, beginning with a quote from Warren Buffett -- "I often make more money when I am snoozing than when I am active" -- it makes a powerful case for patience, not short-termism, when it comes to investing. Long-term buy and hold, it seems is back in favour -- at least with the regulators at the Bank of England.
Disconnect
Pointing to the huge growth in high-frequency trading and short-term financial instruments such as derivatives, Mr Haldane notes that the average share is now held for just seven months, down from two years in the 1980s and five years in the mid-1960s.
Despite Warren Buffett's oft-quoted phrase "our favourite holding period is forever", in other words, investors seem to be admiring Buffett's results while doing something completely different with their own portfolios.
Misalignment
The returns speak for themselves. Mr Haldane posits two groups of investors with very different trading strategies: one, "the speculators", who buy when prices have risen in the previous period (and sell when they have fallen); and another, "the fundamentalists", who buy when prices are low relative to fundamentals, and sell when they are high.
Portfolios are evaluated and re-optimised on a monthly basis, based on a £1 initial stake. How would these strategies have fared historically?
The answer isn't what you might expect. Starting in 1920, the value of the speculator's £1 stake would have risen today to around £1.56, while the fundamentalists' stake would have fallen to 32 pence. Performance in the US was even worse when measured on a longer timescale.
Why? Because, argues Mr Haldane, share prices have become increasingly divorced from the underlying value (and income streams) of the businesses that they represent, driven by excess volatility and a whole series of market inefficiencies associated with short-termism. (Mr Haldane lists and explains seven of these -- there just isn't space to go into them here.)
It doesn't have to be that way, of course. Now imagine that a $1 stake is placed in 1967 with an investment firm whose motto was "our favourite holding period is forever".
By 2009, that long‑term investor's stake would have risen to $2,650. Over the same period, the momentum traders' stake would have returned $75. Buy-and-hold would have out‑performed bought-and-sold (of whatever flavour of trading strategy) by a factor of around 36.
What does it mean?
Mr Haldane's job description at the Bank of England doesn't include doling out free advice to investors like you and me. And that isn't his purpose. He's a regulator, and it's telling that the paper concludes with the following words:
"Just as patience can ward off great disaster, impatience can ruin a whole life. Generations of dieters and addicts are testament to that. So too is finance, not least in the light of the crisis. It is important that finance sticks to the patient evolutionary path. To do so, the fidgeting fingers of the invisible hand may need a steadying arm."
In short, those fidgeting fingers -- hedge funds, activist funds, momentum traders and high-frequency trading algorithms -- might well find themselves more constrained in future.
Buy for the long run
But there is a message for private investors, even if it's unintentional. Wisely-chosen shares, bought for the long-term, will ultimately deliver the exceptional returns that investors yearn for -- just as they have for Warren Buffett.
Where to start? Companies such as GlaxoSmithKline (LSE: GSK), Tesco (LSE: TSCO) and Vodafone (LSE: VOD) look like decent long-term bets to me: solid businesses with reasonable finances that cough up a healthy share of earnings as dividends.
And as a fan of FTSE All-Share index trackers, I'd wager that buying-and-holding the UK market wouldn't turn out so badly, either. Costs are low, and -- in the FTSE All Share, at least -- there's minimal intra-index churn.
Select global investment trusts are likely to add a little foreign frisson of diversification, too. I like Scottish Mortgage (LSE: SMT), for instance. Witan (LSE: WTAN), too, is worth a look, although its present multi-manager investing approach only goes back to 2004.
Echoes of Taleb
In many ways, Mr Haldane's paper reminds me a lot of Nassim Nicholas Taleb, and his books The Black Swan and Fooled By Randomness. It is equally full of throwaway quotes with more than a nugget of wisdom behind them.
Just for fun, here's a taste:
- Addictive behaviour appears to be more prevalent in humans than in animals. While few squirrels are dieters, even fewer are glue-sniffers.
- Expecting a longer life, happy people defer immediate gratification and save. In consequence, they enjoy a more prosperous tomorrow as they harvest the fruits of their investment.
- Between 1 million BC and 50,000 BC, world GDP per capita was roughly unchanged.
More from Malcolm Wheatley:
> Malcolm holds shares in Tesco, GlaxoSmithKline and Scottish Mortgage.
> For two weeks in September we will be opening the doors of our Champion Shares PRO newsletter service. In order to keep our exclusivity, only a select number of our readership will be able to join us. This is your chance to guarantee your place! Click here to join the priority waiting list.
