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Long haul – In the world of investment, a bird in the hand is not always worth two in the bush

19/02/2016

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

No matter how many times investors are enjoined to ‘Take a long-tern view’, the fact remains it is not human nature to do so. Offer someone the choice of £100 in 12 months’ time or £120 in 13 months and the chances are they will feel able to wait a month to pocket the extra £20. Offer them £100 now or £120 in a month, however, and there is a strong probability they will take the £100 and run.               

Clearly, then, it is not our inability to wait one month for an additional £20 that is, in principle, the central problem here. Rather, it is that we would much rather have something now than wait any time at all for the prospect of an incremental uplift. In short, there is something in the human brain that focuses on short-term rewards. 

Scientists, as is their way, have put different species of monkey through a similar test to the one in our first paragraph – although, reasonably enough, they switched the promise of extra cash for one of extra food. In the test, the monkey had the option of hitting a button that dispensed two food pellets immediately or a button that dispensed six food pellets after a short delay. 

The scientists wanted to ascertain how much extra time the monkeys were willing to wait to receive the added reward and discovered that – depending on the species of monkey doing the button-pressing – it was anywhere between eight and 14 seconds. Once the delay grew any longer than that, however, it was found they would much rather revert to the ‘immediate gratification’ option of two food pellets. 

Most human beings have the ability to hold out a little longer than 14 seconds but there is still a point at which, like the monkeys, we conclude it is not worth the wait. Brain-scans carried out when people are taking these sorts of tests reveal that the parts of the brain most stimulated by the idea of instant rewards are located in what is known as the ‘limbic system’. 

This is the more primitive and subconscious part of the human brain (what the Nobel Prize-winning behavioural theorist Daniel Kahneman has termed ‘System One’ thinking as opposed to the more rational ‘System Two’ variety) that controls our basic emotions and drives – fear or pleasure, say, hunger or the instinct to look after our children.               

As is so often the case, this all stands up in evolutionary terms. Tens of thousands of years ago, it would have typically made more sense, more often, to take advantage of whatever food sources were immediately to hand rather than holding out in the hope of something more appetising down the line – and the same holds true with any number of other aspects of Neanderthal existence. 

Unfortunately, as we have seen in other contexts – in articles such as Under the influence and What would Kermit do? – the behaviours and instincts that worked so well for our early ancestors are not only pretty unhelpful in an investment context, they are also very difficult to shake off. Then again, as pieces such as those also argued, this tends to work in the favour of disciplined value investors. 

In this instance, the part of the human brain that views a reward earned in a short period of time as superior to one that must be waited for – and thus leads investors to pursue short-term gains even when the probabilities are against them – creates opportunities for those following a value philosophy, of which a long-term view is of course an integral part.

Author

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.

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