Where private investors have an ‘edge’ over the pros– with Joe Wiggins

The short-term pressures faced by many professional investors mean adopting a long time horizon can give their private counterparts a huge advantage, argues behavioural expert Joe Wiggins

26/10/2021

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

Liam Nunn

Liam Nunn

Fund Manager, Equity Value

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One sweetie now – or two a bit later? That is the essence of the ‘Marshmallow Test’ Professor Walter Mischel first ran at Stanford University in the US in the 1960s to assess the willpower of four-year-olds. Some kids held out for a bigger reward but most did not – and a similar pattern persists decades later in the world of investment. Delayed gratification evidently does not come easy to most human beings, regardless of age.

Three years ago, Joe Wiggins, the author of the Behavioural Investment blog – one of our favourites, here on The Value Perspective – came up with no fewer than 50 Reasons Why We Don’t Invest for the Long Term. So when he recently appeared as a guest on our podcast, we asked him to narrow down his list to identify the key reasons investors focus on the short term. (Yes, it was for reasons of time and, yes, we get the irony.)

“When thinking about time horizons, probably the most important thing for most investors is the problematic disparity between short-term considerations and long-term objectives,” Wiggins begins. “There is, I believe, a structural problem with how asset managers assess the results of their own business and what that means for how they might incentivise their fund managers and the environment they might create for investors.

“Most fund managers have a stated time horizon and a real time horizon. The stated one is what they put in their investment philosophy and tell investors, while the real one is what drives their behaviour. It might be down to how their bonus is paid or their fund being in outflow or the need to improve short-term performance because they are under pressure from their bosses and are trying to manage career risk.”

Beholden to randomness

The key point is, Wiggins maintains, the odds of the game change materially when you alter the time horizon – the odds of the FTSE 100, say, producing a positive return tomorrow is effectively a coin toss whereas the odds of it being up in 10 years’ time, history suggests, is more in the order of 80% or 90% in your favour. “When you have a short time horizon, you really just become beholden to randomness,” says Wiggins.

“If you think about the spectrum running from luck to skill, investing will move along it, depending on the time horizon you are using. Over one day, it is just a lottery but over 10 years, depending on what you are thinking about, then the odds move in your favour and it becomes much easier to make accurate, broad forecasts about what might happen.

“I have no idea what will happen in markets over one year – and I have no idea why professional investors spend so much time talking to clients about what is happening in markets today, tomorrow, last week or whatever because it is creating all of the wrong behavioural impulses and it is based on things we just cannot predict.

“One thing I find deeply frustrating is how professional investors spend so much time looking for ‘edges’ and, while a long-term investment horizon is this glaring and available edge, nobody is really willing or able to take it because of how the industry has evolved. It just seems a huge opportunity for any firm that can be bold in stating – we want to be good long-term investors so this is how we have structured our environment.

Massive ‘edge’

“Somewhat ironically, then, there is a massive edge here for private investors because they can take a long-term horizon without any of the short-term pressures faced by most professional investors.” At this juncture, here on The Value Perspective, we feel compelled to highlight our oft-stated line that investors in our portfolios should have a minimum time horizon of three to five years and preferably rather longer.

We can also point to articles, such as Action stations, that align us with Wiggins on the related issue of an inherent bias among most investors that doing something is always preferable to doing nothing. Indeed, Wiggins mentions the same study we reference in the aforementioned article that notes goalkeepers actually have three options when facing penalty kicks – dive left, dive right or stand still – but never do the latter.

“Penalty-takers can and do kick towards the middle of the goal but goalkeepers always dive to their left or right,” he explains. “That is because, if they stand still and the ball goes to one side, they think it looks worse – as if they did not even try. It is not a perfect study but the concept of action bias is right and there are similar themes here to what we see in the investment industry.

Doing nothing is so often the best course of action for investors to take – particularly if they have a long-run horizon – but because markets are active, because they are chaotic, because they move, because there are so many narratives, it is presumed we must always be active as well. So often there is a dissonance between what is good for your career or what sells and what is a good investment decision.

Terrible temptation

“You only need to look back to the onset of Covid-19 last year and the savage share price falls that were allied to an unprecedented economic shock. There was a huge amount of investor activity and it felt like a fantastic time to sell up and de-risk. But it was just a temptation to make a truly terrible decision – one that was costly in the short term and would have compounded to be a lot more so over the longer term.

“I always think the crises we face as investor, which often end up looking like a blip from a long-term horizon, do tend to define your investment outcomes – not because of the crisis itself but because of what you do during them. The mistakes you make during those periods of emotional distress tend to have a huge bearing on your long-run investment outcomes.

“Again, it comes back to the need to prove you are doing something to justify your fees, even if that is the opposite of a sensible course of action for investors. So there needs to be a lot more willingness to educate clients about the benefits of taking a long-term approach and what that means and creating an environment that encourages such an approach and where you are not compelled to action during difficult market events.”

At the risk of repeating ourselves, this is also an idea we regularly reference, here on The Value Perspective – in articles such as Rules to navigate a market crisis and Pressing the reset button on decisions – often accompanied by the great line from US banker and philanthropist Shelby Cullom Davis, who observed: “You make most of you money in a bear market, you just don’t realise it at the time.”

Magic wand

If Wiggins had a magic wand, then, what one thing would most improve investment decision-making? “I would probably try and restrict the number of investment decisions people could make,” he replies. “That frequency of activity is a massive problem, which feeds into the short-term pressures faced by professional investors that we have already talked about.

“Checking portfolios less, checking markets less – it is not something professional investors can reasonably do, unfortunately, but it is definitely something private investors can do. So just change the frequency with which you engage with your portfolio and with markets because there is a huge amount of noise coming from markets and not a lot of it is material in terms of your long-run investment outcomes.”

Author

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

I joined Schroders in 2015 as a member of the Value Investment team and manage the European Value and European Yield funds. Prior to joining Schroders, I was responsible for the UK research process at Threadneedle. I began my investment career in 2001 at Dresdner Kleinwort as a Pan-European transport analyst and hold a Economics degree.

Liam Nunn

Liam Nunn

Fund Manager, Equity Value

I commenced my investment career in 2011 at Schroders as a European equity analyst. I then moved to Merian Global Investors in 2015 to work as an equity analyst & fund manager before returning to Schroders to join the Global Value team in January 2019. I manage Global Income, Global Recovery and Global Sustainable Value.

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