It’s About Time
If people put money away for long-term goals rather than near-term expenses, why are their investment decisions so short-sighted? Over the past 30 years, we've seen investment time horizons become shorter and shorter. A parent with 15 years to save for college might actually change investments after three years – less time than it takes for their child to earn a degree. The sponsors in charge of overseeing retirement plans, with investment horizons that are measured in decades, are making decisions based on track records as short as one year. There's a dangerous disconnect between distance to the goal and investor behaviour.
It's about time we address the investment horizon dilemma. That's far more pressing than what I often get asked about – the active/passive debate. Like growth and value strategies, active and passive each have their roles and can co-exist in a portfolio. What can't sit side by side is short-term thinking and long-term goals. Many investors have become performance chasers, investing in the moment, not for the future. And they've lost sight of their greatest asset – time.
In recent years, holding periods for stocks have shrunk to an average of less than a year. From risk-on/risk-off – to the proliferation of narrowly-focused ETFs, a trading mentality has gripped the industry as everyone tries to guess which way the markets are heading. That's a tough way to make money ‒ and it's largely unsuccessful.
And yet, many investors are still caught up in the short-term frenzy ‒ constantly trading in and out of funds. Often that means selling managers with proven long-term records to buy the current flavour of the month. In most cases, these investors are buying high and selling low ‒ a surefire way to destroy value.
Short-termism Is Pervasive
Although buy and hold is an easy concept to understand, it’s become increasingly hard for investors to embrace. Even more experienced investors have started to succumb to short-term pressures.
In fact, in a recent MFS survey of the people who oversee U.S. retirement plans, 60 per cent said they consider a track record of three years or less when hiring an investment manager. And 75 per cent said they would put a manager under review for underperformance over one or three years. 1
This short-term thinking makes no sense. These individuals oversee retirement plans with investment time horizons as long as an employee's entire professional career. Yet they're making buy and sell decisions based on time periods shorter than it might take an employee to go from one job grade to the next.
Give A Bull And A Bear
You can only judge the success of any investment strategy, or the relative skill of any manager for that matter, by looking at how they perform in both a bull and a bear market. Investment strategies that attract lots of money by putting up eye-popping returns when markets are rising often blindside investors when the markets turn. It's better to find investment managers who hold up well through both – which takes a good seven to 10 years or a ‘full market cycle.’
If you're only looking at track records of three years or less, you're missing half the picture and making decisions based on pressure, not insight. Many investors bought high-flying tech portfolios at the end of the 1990s hoping to make quick returns rather than wait for slower, steadier value funds to bear fruit. And ultimately it was the value funds that significantly outperformed at the beginning of the new millennium.
That same impatience also drove investors from active to passive strategies over the past few years, as stocks moved in lockstep with one another and fundamentals were discounted. We may be reaching a similar inflection point today, but this time, it will be active managers – especially those who are able to generate outperformance, or alpha, that will carry the day.
Alpha Matters More
In my career, I have never seen an environment like the one we're in today. Interest rates are at historically low levels all over the world. There is more than $13 trillion in global debt carrying a negative interest rate. This has created a perverse situation where investors actually have to pay borrowers for the right to loan them money. And when you couple that with extremely high levels of government debt and low global growth rates, it's easy to see why investment returns will likely be much lower in the years ahead.
Historically, investors could reasonably expect annualized returns of about 10 per cent in equities and five per cent in intermediate bonds. In the coming years, many expect those returns to be cut in half. This will put a huge premium on the value of alpha, as most investors simply won't be able to reach their savings targets through benchmark returns.
Even the best investors will underperform at times – sometimes for a few years in a row. The secret to their success, however, is their ability to take advantage of the opportunities that come from taking a long-term view in a short-term world. Time arbitrage, as I call it, simply comes down to having the conviction and discipline to allow enough time for good investment ideas to play out. For investors, instant gratification is ultimately a loser's game. But time is an asset.
Michael Roberge is co-CEO and chief investment officer at MFS Investment Management.
1 About the survey: MFS Investment Management partnered with Brightwork Partners, an independent third-party research provider, to design and field a study among plan sponsors and financial advisors in North America and Canada. The sample totaled 929 respondents, broken out as follows: 606 plan sponsors and 313 financial advisors. The survey was conducted from September 8, 2015 through October 2, 2015. MFS was not identified as the sponsor of the survey.