Short-termism a challenge for investors

From
Julian Beaumont,

Julian Beaumont,

Australian share market investors are increasingly focused on unsustainably quick gains rather than long-term growth, says Julian Beaumont, investment director at BAEP, in his recent paper entitled: A long story told short.

“We no longer own equities, we rent them. Three decades ago, the average holding period for Australian shares was more than six years. This has now declined to just one year. In aggregate, investors can only suffer from this increased activity, owing to the additional costs of trading and taxes which can be considerable.”

He says it is not just retail investors who are at fault, but that many professional investors also yield to the short-term temptation.

“The pressures of closer client scrutiny mean short-termism can be even worse for professional investors. Fund managers are required to report their performance on a monthly basis, a timeframe that is at odds with the long-term nature of equities.

“As well, many clients, both retail and institutional, very often look to short-term performance in determining whether to invest in a fund. For managers, significant short-term underperformance comes with the risk of losing clients, so they become overly focussed on short-term results.

“The risk of client loss also forces many fund managers to become risk averse. And standing out to make a difference comes with the real risk that you fail miserably and, worse still, that you do so alone.

“In an attempt to avoid this many fund managers will hug the index closely, with similar portfolios that are designed more to avoid failure than to add value.”

Investors’ short-termism can also permeate to the corporates themselves, he says.

“Corporates feel significant investor pressure to deliver on short-term expectations and to avoid risk that might jeopardise this.

“To the extent that CEOs have long-term incentives, the performance period over which they are determined is typically just three or four years, a time period that is too short to see through the full lifecycle of corporate planning.

“Thus, a CEO might choose to put off investment in research projects, product development or other long-term projects that come with additional costs today but could add material value further down the track. These CEOs then fall into the same myopic and low-risk strategy that many professional investors fall foul of.”

Short-termism is also apparent at the board level of listed companies, he says.

“In Australia, as elsewhere, boards have acquiesced to the desires of shareholders to maximise dividends. This calendar year, ASX-listed companies are expected to pay out dividends representing an average of 75% of earnings. With the addition of buy-backs, these companies will be returning to shareholders approximately 85% of their earnings. This is a multi-decade high, well above an average of approximately 50% in the 1980s, and obviously leaves very little for investment.

“The ability for companies to reinvest and grow makes equities quite a unique asset class. It is in fact one of the main attributes that allows equities to offer investors capital growth. Reinvestment can add to earnings and create shareholder value.

“As highlighted recently by the RBA, prioritising dividends over investment has broader economic implications. In Australia, as in most developed countries, a lack of corporate investment has been given as a reason for the insipid economic growth. Corporates are apparently too generous with dividends and are left with little to spend on new plant and equipment, hiring and training, and research and development.

“In our view, the Australian share market is systemically short sighted. Its value bias means that it is very often overly focused on PE multiples and dividend yields that rely on just the next year’s estimate of earnings or dividends. Ordinarily, either of these will account for less than 10% of a company’s total valuation.

“This market’s focus on the short term can very often undervalue earnings that are reliable and growing strongly over time, where compounding is left to work its magic.

“Fundamentally, investment is about giving up current consumption for potentially greater consumption in the future. Within this context, and by their very nature, equities represent a form of investment that provides for retirement and other long-term goals.

“Focusing on the constant noise of real-time quotes and never ending news flow is to forget about the goals most use equities to achieve,” Julian says.

A copy of the full version of the paper can be found here.

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