If we were to use one word to sum up investment markets over the past year then “volatile” would be quite apt. Our immediate thoughts might turn to the large swings we have seen in share prices since the turn of the year, and more recently the result of the referendum. But significant and sharp changes in asset prices have also been witnessed in lower-risk fixed interest investments such as Gilts, commodities, and more recently, agricultural land.
Volatility has, of course, always existed within investment markets. But recent changes in society, technological advances and the creation of new investment products has seen capital flow in and out of various investments and asset classes over very short time periods, thus creating volatility. Can this continue and, as investors, what can we do?
Changes in society
We have seen a dramatic change in some parts of society over the past few decades. There is an increasing desire among many for instant gratification. We can see evidence of this with the significant increase in household debt and a reduction in savings. Why gradually save and wait for your new car, holiday or TV when you can bring that future purchase into the present, via debt? But it is not only our spending (or not saving) habits that have changed. We can now watch films and television programmes, whenever and wherever we want. And particularly with the millennial generation, the need for instant gratification exists through social media where we share our lives and thoughts and hope to be “liked”.
Taking short-term views and seeking quick results are not just the preserve of consumers. It is now a new concept in investment ‘trading’, but for some, even equity investment, a core for long-term investors, has a shortened life expectancy.
The average holding period for equity investments supports the argument that investors have become more short term in their time horizon. The average holding period for equities has fallen steadily since the 1980s, when it was traditionally estimated to be around five years. Although difficult to calculate, it is estimated that the average holding period for an equity is now measured in days rather than years.
It would be foolhardy not to recognise the role technology has played in granting investors the ability to move quickly between various investments. Computing power has been growing exponentially and has allowed investors, across a variety of investment markets, to trade quickly and effectively.
But the improvement in technology also allows vast amounts of information to move around the globe almost instantaneously and to be analysed far quicker than any human could do.
These elements have, of course, led to an increase in High Frequency Trading (HFT), popularised through the Michael ewis book “Flashboys” and has been thought to have taken place since at least 1999. There are various different and complicated trading strategies that the HFT firms use but ultimately they are characterised by high speeds, high turnover, and look to make very small gains on a significant number of frequent trades using complex computer algorithms and high speed networks.
The ability to trade individual investments relatively quickly and cheaply has existed for some time. However, more recently we have seen a proliferation of exchange traded funds (ETFs) which make trading a whole market or sector quick, simple and low cost. Indeed, we can now access even more investment markets and sectors.
Exchange traded funds and derivatives have been the enablers that have allowed the short-term minded investor, supported by technology, to trade on a regular basis and move capital around like a hot potato.
What can we do?
The previously discussed points could indicate that shorttermism, and accordingly volatility, might be here to stay. As investors and allocators of capital we need to look beyond short-term movements and firmly fix our time horizon over the long term.
Indeed, the whole premise of any investment is about committing long-term capital to a business. With equity investments the fortunes of the business and shareholder are aligned and, over time, we should expect capital to flow from inefficient businesses towards better quality companies. What we are currently witnessing is not investing but trading and more akin to gambling.
But time is the greatest tool that any investor has and it is being squandered. There have been plenty of studies that show the chances of losing capital are greatly increased over shorter time periods.
Some investors, understandably in particularly volatile markets, can focus too much on short-term performance and lose sight of their original objectives. Most charities have a long-term time horizon and can afford to ride out some short-term volatility. So while it may be nerve-wracking at times, trustees and their investment managers need to keep any concerns about short-term performance in the context of their long-term aims and objectives.
As an investor, we are free to trade only when necessary, which could be never. Indeed, Warren Buffett (the world’s most successful investor) defines his ideal holding period as forever. It ties back into what stock markets were created for: to commit long-term capital to good quality businesses.
It seems unlikely that the financial industry will revert back to longer holding periods and herein lies the opportunity for the long-term investor. The stock market has always acted as a relocation centre at which money is moved from the active to the patient.
By Greg Hulse Divisional Director
The value of investments can fall and you may get back less than you invested.
Past performance is not a guide to future performance.
No investment is suitable in all cases and if you have any doubts as to an investment’s suitability then you should contact us.
All information within this article is for illustrative purposes only and is not intended as investment advice; no investment is suitable in all cases and if you have any doubts as to an investment’s suitability then you should contact us or your financial adviser.