Three interesting reads on investment horizons


Read the highlights from three papers on investment horizons. Learn about the relationship between holding period and performance in mutual funds, the holding period among different types of Norwegian investors, and one Nordic asset manager’s take on long term investing.

In a 2011 Wired interview, Amazon founder and CEO Jeff Bezos talked about running the company with a long-term view: “If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue. At Amazon we like things to work in five to seven years. We’re willing to plant seeds, let them grow—and we’re very stubborn. We say we’re stubborn on vision and flexible on details. In some cases, things are inevitable. The hard part is that you don’t know how long it might take, but you know it will happen if you’re patient enough.”

The same thing is true for equity investors. If you are willing to invest with a longer time horizon than most investors, you can improve your chances for a good long-term return.

Below are the highlights from three papers on investment horizons.

Holding Horizon: A New Measure of Active Investment Management
by Chunhua Lan, Fabio Moneta, and Russ Wermers. July 2018 draft.
If you prefer to read the whole paper, click on the picture below.

The paper by Lan, Moneta, and Wermers finds that long-horizon funds outperform short-horizon funds measured on a risk-adjusted return. At the stock level, those with high ownership by long-horizon funds also outperform stocks with high ownership by short-horizon funds.

The paper calculates the holding period using two different methods. The first calculates the holding period from the time a position is first initiated to the time it is completely liquidated. Because this measure “looks ahead” it cannot be calculated in real time. Therefore they introduce the second measure (Ex-Ante Simple) that only uses current information and therefore underestimates the holding periods as it includes holdings not yet sold.

The paper uses a sample size of 2,969 equity funds over a sample period from 1980–2010 and includes U.S. actively managed equity mutual funds.

Here are some of the key findings from the paper:

  • Funds in the shortest-horizon quintile hold stocks for an average of 2.02 years (1.01 years for Ex-Ante Simple measure), whereas funds in the longest-horizon quintile hold stocks for 7.39 years (4.47 years for Ex-Ante Simple measure).
  • Long-horizon funds outperform short-horizon funds. The four-factor alpha for the longest-decile funds is positive and is the highest among the deciles. In contrast, the alpha for the shortest-decile funds is negative. The spread of 5-year alpha between the longest and shortest decile funds is 9.1% (1.82% per year).
  • At the stock level, they find that stocks with large long-horizon fund ownership offer higher long-term returns than stocks with large short-horizon fund ownership. However, there is no evidence that stocks with large short-horizon fund ownership perform well in the short run. The average 5-year buy-and-hold performance of the top decile stocks (the ones with the largest long-horizon fund ownership) is around 90%. The average bottom decile return is around 69%. The difference in 5-year return is 21% or 3.9% per year.
  • According to the paper, an explanation is that long-horizon fund managers are skilled in analyzing long-term firm fundamentals and select stocks with strong long-term fundamentals.
  • Long-horizon funds also tend to attract more long-term investors than short-horizon funds. They raise more capital via share classes with up-front load and lower annual charges.

How long do equity owners hang on to their stocks?
Working paper by Bernt Arne Ødegaard. June 2017
If you prefer to read the whole paper, click on the picture below.

Given the findings described above, it is interesting to look at professor Bernt Arne Ødegaard’s working paper on holding periods in the Norwegian stock market. Ødegard, professor at the University of Stavanger, examines the median holding periods by investor type based on access to the complete records of ownership of Norwegian stocks for a 15-year period (1992–2007).

It is important to notice that the two papers use different measures of holding periods and these are not directly comparable. But this paper gives a clear picture of the short median holding period in the market.

According to the paper, the median holding period in the Norwegian stock market is only 0.75 years. Private investors have the longest median holding period of 0.833 years while financial owners have the shortest of 0.499 years.

Holding periods also vary by industry. Energy stocks have the shortest median holding period of 0.67 years while telecom stocks have the longest with 1.42 years.

The paper also shows that an equity owner is less and less likely to sell a position as time passes. For example, during the first year, a lot of positions are sold. If an investor holds the stock throughout this period, they are more likely to keep it longer term.

Both this paper and the one above argues that turnover (inversed) is a not a good proxy for holding periods, even though it is often used in the industry.

The Next 30 Years
White paper by C WorldWide Asset Management Q1 2018

C WorldWide uses a bottom-up stock picking approach with a trend and theme influenced top-down overlay. They invest in a combination of stable growth companies and companies with exposure to attractive long-term themes.

Earlier this year Bo Knudsen, portfolio manager and CEO of C WorldWide, wrote a white paper called “The Next 30 Years”. He writes about the importance of thinking long-term and highlights three themes that are likely to be attractive places to look for long-term investments.

On long-term investing, he writes: “It can be easier to predict long-term themes than to predict the next few months. This certainly is very helpful for the long-term fundamental investor.” “Even though deep understanding of a company’s business model and competitive environment is a necessity for a successful stock picker, the devil is not always in the details. The difficult part is understanding the long-term trajectory and staying on course, when the sirens are tempting you to change and deviate away from the long-term trends due to a short-term ‘wind of change’. It is about getting the big picture right and staying the course.”

In the white paper, three themes are identified to help find companies with attractive long-term exposures. Experiences, Urbanization, and India. The Experiences theme includes content, travelling, hospitality, and aspirational products. The Urbanization theme includes areas such as cities growing higher, wider and more intelligent, as well as solving problems of higher levels of crime, stress, and waste in cities.

The third theme is India: “India’s Gross Domestic Product (GDP) is 1/5 the size of China’s and at level with the GDP of France today, having a population that is more than 20 times bigger. That will change… This is not reflected in the market indices today. HDFC has a similar market cap to Nordea, who serves a market with 100% mortgage penetration and a population of 25 million in the Nordic versus India’s 9% mortgage penetration and 1.2 billion people. Benchmarking to the future rather than the past should guide investors to a markedly higher exposure to India.”

Not all long-term growth stories give attractive investment opportunities. As the paper states on the growth of electric vehicles: “It is hard to identify who the winner will be in this capex intensive industry and at this stage, where a fundamental shift to electrification takes place, the strategic stock picking risk is high. We are therefore not investing in car manufacturing at this point in time”.

You can read the whole white paper and other C WorldWide whitepapers here.

 

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