In the past few months, the focus on the ‘short term’ has increased substantially. The pandemic has got us chasing near-term data points. Equity markets have risen sharply, and a lot of new retail investors have entered the market. Studies have shown young and inexperienced investors typically trade more frequently, follow trends (herding), chase hot stocks and end up taking higher risk.
The unprecedented sharp bounce has left a lot of experienced investors with the feeling of missing out and a lot of them are yearning to participate in the market rally. Trading apps do not force investors to trade, but they definitely persuade them by constantly sending out price alerts and notifications. There is pressure on institutional investors too, as financial media and social networks are discussing how funds performed in the last 4-5 months, instead of their long-term track record.
The rise of passive funds, algo traders and high frequency traders has tipped the scale further towards investors focused on the short-term momentum. And, of course, leveraged investors are anyway forced to react to short-term news flows rather than long-term company fundamentals.
But the fact is now is the time when, more than ever, investors need to have a long-term view.
TAKING A LONG-TERM VIEW
As it is clear from the facts mentioned above, there is very less competition if you are looking to invest with a long-term perspective. Since a majority of investors are trying to outsmart each other in the near term, joining this herd is likely to generate only average results. The opportunity for superior returns is in looking beyond three years (5-10 years is better) and investing in businesses or investment themes that are not fully appreciated by this crowd.
Once you change the investment horizon, the entire view on market movement, asset allocation, fund manager selection and stock selection changes. The benefits are huge, and how!
- Love the downturns: When you have a longer investment horizon, you are prepared for a crisis. Even good businesses may go through downturns. But with a longer-term view, you would be ready to participate in it by adding to the positions during a fall. A lot of short-term investors miss out on a good business by trying to frequently trade in and out of the stock. Even a second wave in Covid pandemic and the resultant downturn can be used intelligently by an investor, who is investing with a decade’s outlook.
- Take advantage of crowd biases: Typically the crowd, which is dominated by short-term and inexperienced investors, is guided by biases like greed, fear, myopic loss aversion, recency bias and over-reaction or under-reaction to new information. Broaden your horizon and use the crowd-level errors to your advantage. This is often referred to as ‘Time Arbitrage’ as it involves making an investment in an asset with good long-term prospects at a time when it is facing short-term challenges.
- Enjoy a broader opportunity set: Herding leads to market participants staying focused on certain hot stocks or glamour stocks and ignoring a lot of other companies that may have good businesses but are under the radar. Short-term investors concentrate on stocks that grab their attention either due to their sharp movement or media coverage. A long-term investor is looking for a good business at a good price. Since noise or liquidity are not much of a consideration, one is able to have a larger number of companies to choose from.
- Capture important themes and styles: Certain macroeconomic themes (like return of global inflation), demographic themes (increased women’s participation in workforce), geopolitical themes (Atmanirbhar Bharat) unfold over many years. Only long-term investors can fully utilise the wealth creation opportunity in industries and companies that benefit from these themes.
Also, investment styles like value investing require patience and long-term horizon which these investors can utilise.
- Filter out the noise: A market participant is bombarded with a lot of information, whether material or not. And it is difficult to differentiate between signal and noise. Using the filter of a long-term orientation, a lot of data points which are of low significance can be removed.
- Bond with your friends who believe in market efficiency: You obviously want the value of bargains that you discovered (by the actions of short-term investors) to be realized over the long term. As Benjamin Graham said, “In the short run, the market is a voting machine, but in the long run, it is a weighing machine”. Join your friends who believe in market efficiency and secretly hope this time the crowd overreacts on the upside.
THE RIGHT SUPPORT
Just having a long-term view on the investments cannot guarantee success. There are also some other problems that the investor will be encountering. I have listed some important ones with suggestions to handle each one:
- Future is difficult to forecast accurately. It is also difficult to find third-party long-term forecasts as most of the analyst make only near-term projections (within a period of 1.5 years). A diversified portfolio bought with a margin of safety can cushion the investor from possible errors in forecasting.
- There is a career/business risk if the client or the organisation is not supportive of the strategy. Set up the right ecosystem with clear communication of strategy and expected outcomes. Incentive structures can also be set based on long term results.
- Time is a friend of a wonderful investment but the enemy of a bad one. The investment horizon has to be backed with a good investment process of evaluating and selecting investments.
The right support structures (clients, organization, team, investment process) might help an investor on the path of long-term wealth creation. However, on a personal level, the investor may have to maintain the discipline. It is tempting to join the crowd and easier to focus on the next quarter than next decade. It will however be far more lucrative to resist the temptation and turn your investment horizon into your investment edge.