Concerns about short-termism in markets, government thinking and corporate strategy have only increased in the wake of the global financial crisis and the resulting levels of uncertainty surrounding investor and business behaviour have led to a raft of initiatives from politicians, business leaders and academics examining how best to address the issue.
Unfortunately, a famous experiment conducted in the US in the 1960s, in which young children were offered the choice of one marshmallow immediately or two after a short wait, suggests short-termism is an integral part of human nature. The reactions to the test illustrate two common manifestations of our natural tendency towards short-termism – an excessive discounting of the future in favour of the present and an innate bias towards action.
As such, few market participants emerge without blame, with companies, shareholders, traders and politicians all increasingly short-termist, irrespective of the social and other costs. Research by J. P. Morgan, for example, has indicated a focus by US businesses on quarterly earnings to show short-term profits is leading public companies to defer spending on research and development.
Other factors exacerbating things include shrinking public company CEO tenures and the rise of new types of trading shareholders, such as hedge funds and private equity. Overall, shareholders on average now hold their stocks for less than a year, with institutional investors particularly bad as managers admit to making decisions that can harm a company in the long term in order to meet short-term earnings expectations.
According to Kent Greenfield in his paper The Puzzle of Short-termism, the addiction to leverage, derivatives and greed that caused the market to become a “casino” in the run-up to the financial crisis would only have been possible in a business culture where short-term gains are prioritised over long-term costs. As such, he argues, the problem of short-termism is very real.
Two important initiatives have recently emerged from a governmental level in the UK – the Kay Review of 2012, which examined the efficiencies of modern equity markets, and a report entitled Overcoming Short-termism within British Business by Sir George Cox, which was commissioned by the Labour Party and published in 2013.
Interestingly, the asset managers represented in the Cox report point out their responsibilities differ from company executives. In addition to being shareholders, they argue, they also have a stewardship responsibility to their clients and a valid asset management perspective may therefore be to sell or reduce an investment rather than carry on holding it for the longer term while engaging with the business.
The villains of the piece are not restricted to the private sector, however. By their nature, governments tend to be short-term in outlook, a point neatly illustrated by the way potentially unpopular issues are continually discussed then shelved by successive administrations – the implication clearly being voters can be equally short-termist. This in turn becomes off-putting to potential investors in infrastructure and other public projects.
The Cox report seeks to identify ways in which to incentivise longer-term shareholding, such as introducing more tax relief, but it also notes equity markets now involve the trading of large volumes of equities and stocks at high speeds. In the process they have become largely secondary markets, without actually providing much assistance to the primary investment for which they were originally intended.
At Aberdeen, we would argue that, unless investors need their money back soon, there are two good reasons they should think for the long term and avoid getting caught up in the daily ‘noise’ of markets. First, it makes sense to align their own investment time horizon with that of the companies in which they invest – and all good businesses (and even some bad ones) have a long-term perspective.
Second, short-term price movements are largely temporary and what investors really need to be worried about is permanent loss of capital, which is all about assessing a company’s long-term business prospects. Investing for the long term sounds a simple enough strategy and yet, in today’s fast-paced environment, the desire for instant gratification runs through to investment-return expectations as well.
While the temptation to react to short-term newsflow is huge, however, the losses can obviously be far greater than a second helping of marshmallow. At Aberdeen, we believe shorter-term trading and over-exuberant attempts at market timing are fraught with danger, meaning bouts of often painful volatility must be weathered in order to reap longer-term rewards.
