“Our favourite holding period is forever,” Warren Buffett once famously said. But for a typical equity fund manager, it’s actually a matter of months.
New research, jointly conducted by the 2° Investing Initiative & the Generation Foundation, shows that, on average, a long-only equity manager will turn over his or her entire portfolio every 1.7 years. 90% of them do so within three years.
The report, The Long and Winding Road, warns of worrying implications, both for investors and for wider society.
As Jack Bogle says, “to invest with success, you must be a long-term investor.” The reason is simple. Every time your fund manager trades, there’s a line of intermediaries waiting to be paid, and it’s you, the investor, who picks up the tab.
To quote the report:
“Turnover serves as a proxy for transaction costs. (These) can amount to 1.4% of net asset value and are a drag on equity fund performance. Currently, managers are not fully transparent about the costs they incur through trading, disclosing their gross performance, which is net of transaction costs, but not the costs themselves.”
Now if you’re paying high transaction costs, that will make a huge dent in the long-term net returns you can expect to receive. According to Vanguard, paying 1.4% a year on an initial investment of £10,000, assuming an average annual return of 7.5%, will mean losing 51.5% of your returns over 50 years. And remember, that excludes your annual management charge, as well as any initial charges or exit fees. Even if you’re paying transaction costs of a more modest 1%, you’d still be losing 40% of your returns.
There’s also another way in which high share turnover is bad for investors, and that’s to do with risk.
The report says this:
“Short-term pressures often amount to limited assessment of long-term risks, potentially resulting in suboptimal capital allocation and costly asset liability mismatch for the long term. This implies a fundamental mispricing of assets which, when corrected, could amount to both investor losses and costs borne by society more broadly.”
In other words, it’s not just our retirement savings that are endangered by this game of hot potato that asset managers are playing; there’s a risk to society as a whole. Asset managers have an important part to play, for instance, in encouraging firms to be more environmentally friendly, but if you’re only holding a stock for a year or two, that doesn’t give you time to make any kind of difference.
There are many reasons why asset managers are so focussed on the short term. The way they’re financially incentivised is one of the biggest factors. Another is the demand for investors for short-term outperformance. As the report says, it’s an issue that regulators and governments need to address.
In the meantime, keep your trading to a minimum, and, if you do use actively managed funds, keep a check on how frequently the stocks in those funds are being turned over. Fund managers like to talk about the value of long-term investing, but all too often, what they say and what they do are two completely different things.
You can read the full report here: