A long-term manifesto, revisited

As with any investment, your capital is at risk.

Some of you may remember receiving ‘A long-term manifesto’ from us in 2016, in which we advocated for a long-term investment approach in a short-term world. In this paper, we argued that short-term thinking is becoming increasingly prevalent and has negative consequences for decision makers in general, and those involved in financial markets in particular.

We ran through a potted history of the academic analysis of short-termist behaviour, including economist Alfred Pigou’s 1932 ‘defective telescope’ analogy, the famous Stanford Marshmallow Test experiment in the 1970s, and Daniel Kahneman’s description of ‘System 1 thinking’ where the fight-or-flight area of the brain, the amygdala, takes over decision-making with suboptimal outcomes.

We highlighted the negative consequences of short-termism across politics, business, markets (and marshmallow-loving children) but also why incentives and human psychology – that dreaded amygdala again – nonetheless mean that it has remained pervasive. We concluded by outlining how we, as long-term investors, structure our investment philosophy around exploiting the structural market inefficiency that short-termism creates.

So, what do we think 8 years later?

In this paper, we revisit the subject of short-termism in light of our investment experience over the intervening years and incorporate a survey of the latest academic work on the subject. We conclude by considering whether these latest findings should lead to any changes in our philosophy, approach or the portfolios which we construct on behalf of our clients.

To begin with, there is no evidence that markets are becoming any less short-termist. In recent years, academics have gone beyond anecdotal or questionnaire-based measures to quantify the effects more precisely. If anything, this latest work suggests a further contraction in time horizons.

Sampson and Shi of the University of Maryland used a measure of ‘implied discount rate’ over a 30 year period to measure stock market time horizons. They found that short- termism increased during periods of economy-wide shocks, and that recent years have seen a steady decrease in time horizons. They suggest this feature might be due to “rising exposure to globalization and the increasing pace of technological change that may make firms more impatient for returns and less willing to take on the risks associated with longer-term investments.”

Richard Davies of Newcastle University analysed the impact of excessive discounting by businesses and suggested that “the elimination of short-termism would then result in a level of output around 20 per cent higher than would otherwise be the case.” In 2023, Stephen Terry from the University of Michigan published a paper suggesting short-termism among corporates slows economic growth by 5 basis points per year and “lowers social welfare by about 1 per cent”.

While one can pick holes in the process of reaching precise conclusions based on inherently messy market data, it is notable that survey data backs up these statistical findings. In 2016, The National Association of Corporate Directors in the US found that out of the more than 600 public company directors and governance professionals surveyed, 75 per cent felt short-term pressures were undermining managements’ focus on long-term strategic objectives and value creation.

These findings are remarkably similar to the 2005 study that we cited in our original paper which found that participants “would be willing to reduce discretionary spending on R&D advertising and hiring in order to meet earnings benchmarks”.

Beyond statistics and surveys, sometimes it is the frank admissions from senior management which illustrate the stark reality of short-termism in business. This is from an interview with Dan Vasella, the former CEO of Novartis:

“Once you get under the domination of making the quarter – even unwittingly – you start to compromise in the grey areas of your business, that wide swath of terrain between the top and bottom lines. Perhaps you’ll begin to sacrifice things (such as funding a promising research-and-development project, incremental improvements to your products, customer service, employee training, expansion into new markets, and yes, community outreach) that are important and that may be vital for your company over the long term.”

In our original paper, we made a comparison between the behaviour of public and private companies, suggesting that because unlisted companies are not subject to short-termist market pressures, they appear able to take better decisions. In light of this, it is interesting that in the last eight years the attractiveness of going private has increased markedly.

There seems to be a growing view that public markets are intolerant of the long-term investment needed to fuel disruptive growth. With the increase in the size of private markets, companies have alternative ownership options.

Some of the managers making the move to go private have been very clear about their motivations, linking the attractiveness of delisting directly to the short-termism of public markets. According to Vivek Ranadive, CEO of Tibco Software:

“The whole philosophy is not to think about the short term and focus on having a highly profitable long-term business… I think there will be a large number of companies who will think answering to [Wall] Street is too much of a hassle and will decide to go private… I see this as an increasing trend.”

Michael Dell, CEO of Dell, made a similar point noting that:

“Privatisation has unleashed the passion of our team members who have the freedom to focus first on innovating for customers in a way that was not always possible when striving to meet the quarterly demands of Wall Street.”

Take-private activity has increased steadily and, according to Bain Consultancy in 2022, amounted to an aggregate $700bn, up from $230bn a decade earlier. We have personal experience of this from holdings in the International All Cap portfolio, despite our presence as long-term minded shareholders.

Hargreaves Lansdown, a UK-based online stock brokerage, was the subject of an attempted takeover by a private equity consortium in June 2024. In an unusual move, some existing owners were given the opportunity to continue holding a stake in the business after it was delisted – offering, as The Economist newspaper put it, “the chance of a fresh start away from the glare of public markets”. It appears the delisting was not because the major owners were seeking an exit. Rather it was about getting away from the pressures of public markets.

In a similar move, Nippon Paint, an Asian paint company in the portfolio, delisted two small subsidiaries to allow for a period of re-investment. Nippon Paint said it believed the scale of investment was such that some of its shareholders might baulk at the impact on near-term earnings. Having improved, it has now bought these subsidiaries back into the listed company.

Both examples suggest there is a perception, unfortunately accurate in many cases, that public markets do not have the vision or patience to cope with the short-term impact on earnings of significant investment, even if it is carried out to create value.

Why haven’t things changed?

In my original paper, I ran through the reasons why it was difficult to lengthen investment time horizons, identifying three causes in particular:

1. The remuneration structures most commonly used in the financial industry
2. The influence of investment bank stock research
3. Basic human psychology 

Three books written since our first paper have wrestled with the same topic and come up with some solutions:

• Stock Market Short-Termism: Law, Regulation, and Reform by professor of law Kim Willey,
• Playing the Long Game: How to Save the West from Short-Termism by investment analyst Laurie Fitzjohn-Sykes
• Curing Corporate Short-Termism Future Growth vs. Current Earnings by Gregory V. Milano, a business consultant with a specialism in remuneration structures

All three add worthwhile insights to the canon of research, and in each the solution proposed tends to focus on the author’s areas of expertise.

• Willey considers ‘hard law’ or ‘soft law’ means of changing behaviours
• Fitzjohn-Sykes suggests a change in how investment research is shared among professional investors and a restructuring of investment fund offerings
• Milano sees potential solutions in the KPI’s used for remuneration

The authors also cover the tentative regulatory and other measures that have already been introduced, such as the Florange Law in France, the launch of the Long-Term-Value-Creation Index and the UK and Japanese Stewardship Codes.

However, all three authors also acknowledge the challenges to such reforms and the risk of unintended consequences. Ultimately, none of the authors claims there is an easy and effective solution to the short-termism problem.

Unintended consequences are also the key risk identified by Lucian A. Bebchuk in his Harvard Business Review article ‘Don’t let the Short-Termism Bogeyman Scare You’, where he argues that the cure for short-termism may be more damaging than the illness.

It seems we are in the same situation as we were eight years ago, with plenty of study and analysis of the problems of short-termism but no practical solutions.

On the one hand this is a terribly depressing conclusion; years of study and experience have made us even better at identifying and quantifying the problems but no closer to solving them. But on the other, we must appreciate that economies and markets are complex adaptive systems that will always be imperfect; the best we can do is to tailor our approach to these realities.

What does this mean for the portfolio?

From our view as investors in equity markets, this also means that a market inefficiency persists and can be exploited by long-term investors who are willing to take advantage of it.

Of course, recognising an efficiency is one thing and taking advantage of it with consistent success is another. Simply holding our positions for multiple years will not be enough, we must focus on insightful analysis, consistent assessment of management decisions and sensible portfolio risk management.

However, we do think that a market inefficiency and an approach of discipline and patience, combined with a profound respect for what we do not and cannot know, position us to act differently from the market and deliver returns above the market.

This is how we will continue to invest on behalf of our clients.

Above all, you should still expect us to put a premium on management quality and alignment. In the short-term guessing game of what might happen to next quarter’s earnings, management arguably has limited influence. However, for those who look to hold companies for 5 years, 10 years, or longer periods, management decisions around reinvestment and capital allocation can really make or break an investment thesis. Aligned, trustworthy management remains a prerequisite for us.

In the conclusion of our 2016 paper, we emphasized the importance of aligned management for long-term investors, and highlighted the types of growth opportunities this presents. Our current thinking is that these fall into four growth categories:

1. The first is in 'Rapid Growth' businesses: here the high near-term multiple might act as a ceiling for how much the market is prepared to pay, but the scale of potential disruption means that a long-term holder can benefit from a sustained period of very strong growth.
   
   The poster child for this sort of opportunity is Amazon, over the past two decades. Within our portfolio (which invests only in markets outside the US) MercadoLibre and Spotify are good examples of holdings with an apparently stretched near-term valuation, but a valuation which still does not account for the potential of several years of very rapid growth.
   
   Another type of growth opportunity is in businesses with very strong competitive positions, which we term stalwart or quality growth opportunities. We would split these into two categories: compounders and cyclical growth.
   
   
   
2. Good examples of 'Compounders' in the portfolio would be Rightmove and Air Liquide, where sales growth has been only single digit, but where the strength of the franchise has meant that returns have improved through cycles. This has resulted in a very long duration of cash flow growth, well beyond the default ‘fade rate’ that the market expects. The key characteristic of such businesses is the breadth of the economic moat.
   
   Our contention was that the market tends not to differentiate much between businesses with average competitive advantages and those with exceptionally strong advantages. However, for the latter group, the sustained return on capital often leads to growth and free cash flow that consistently exceed consensus expectations.
   
   
   
3. 'Cyclical Growth' businesses are similar to compounders in that they have strong competitive moats but differ in that they operate in end markets that experience more pronounced business cycles. Examples from the portfolio would be ASML and Epiroc. A feature of this grouping is that the nature of the earnings profile can create opportunities to add to holdings at low points in the cycle.
   
   
   
4. Lastly would be the category of growth companies that we classify as ‘Capital Allocators’. These are companies that can grow sustainably through (normally) small acquisitions. We have always had exposure to companies like this, but we believe it is right to view them as a distinct class that can sustainably supplement organic growth with sensible bolt-on acquisitions. Serial acquiring can transform a company operating in an otherwise lower-growth industry into a multi-year compound growth machine.

Why are these ‘Capital Allocators’ not recognised in advance? Typically, it is because investment bank analysts tend to ignore acquired growth on the basis that it can be volatile quarter-on-quarter and year-on-year, and is therefore difficult to model. Often, there is also an opportunity created by the fact that these successful bolt-on companies operate in what would otherwise be rather slow-growing industries, and are therefore neglected by growth investors.

Several of our holdings have been quietly getting on with an organic plus bolt-on strategy for many years, such as IMCD or Intertek. We recently added to this collection with Bunzl, a UK distributor, and Assa Abloy, a Swedish door entry business. Looking at their track records and their future potential we think they are among the best serial acquirers in the International universe.

We have examples of all of these types of growth investments in the International All Cap portfolio. Naturally, some companies are not obviously one type or another; some have divisions which are rapid growth and others with more compounding growth characteristics within a single corporate entity; others combine a bolt-on and rapid organic growth approach. The boundaries between these buckets of growth are never completely clear-cut.

However, as it stands today, the Strategy is diversified in its exposure between these different flavours of growth. We would expect this diversified approach to continue within the portfolio, with the ultimate split driven by where we find the most attractive new opportunities.

In conclusion

There appears to be no sign of a decline in short-termist behaviour, if anything the opposite, with market participants and investors ever more in thrall of ‘quarterly capitalism’. Short-termism in stock markets continues to be an area where there is plenty of attention from both academics as well as governments and regulators, and, in the years since our original paper, there have been several excellent books that have helped advance the thinking on this topic.

However, despite an awareness of the negative impact of short-termism and a quantification (albeit rough) of its cost, there are no signs of significant changes in behaviour and those reforms that have been introduced have been tentative at best.

It is difficult to address a problem that has multiple causes and there is rightly a concern that any solution might cause bigger problems than it solves. From our current vantage point, we believe that short-termist behaviour will continue to be a fact of life for investors, businesses and markets.

We base our investment philosophy and approach around a belief that short-termism creates an exploitable market inefficiency. Our analysis considers prospective holdings on 5-10 year time horizon and eschews the quarterly obsessions of investment banking analysts. We look for aligned managers who take a long-term perspective and, in our engagements with management, we encourage them to run their businesses with the aim of maximising long-term value creation even at the expense of meeting short-term expectations.

We believe that there are four broad types of opportunity that can be underappreciated by the market: rapid growth companies, high-quality compounders, cyclical growth businesses, and companies that can grow through serial acquisition over many years.

Our aim is to buy the very best that we can find in each of these pools of opportunity and hold them patiently while they deliver attractive returns for our clients.

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The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in January 2025 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

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