ESG advocates and skeptics have strong, but often contrary views, about the merits of long-term investing. As you would expect, the reality is nuanced. For some, active long-term investing in ESG companies is the ultimate ESG play. But most long-term active funds struggle to beat indexes over 10 years, especially after expense ratios and sales loads are factored in. Firms, especially the small ones owned by such long termers, earn alphas over indexes in the long run.
Perhaps newly energized by the rise of ESG investing, increasing discussion and disagreement about the relative merits of “long term investing” have become more common. The pro-ESG side argues that ESG is good for business in the long term, while critics argue that this reliance on long term investing is a way for ESG advocates to duck difficult questions about ESG’s underperformance in the short run. In particular, they assert that (1) the distinction between long-term and short-term investing is artificial; or (2) there is no intrinsic financial benefit in investing for the long term, compared to alternatives. Some simply ask if the long-term investor makes a return high enough return to reflect the time the investment is held.
My questions is more basic: 1) do investors in fact invest for the long term and 2) does long-term investing even work? Do more investors talk the long-run game than practice it (“long washing”)? Do the large indexers, who claim to be universal owners, vote and act as they though they are long-term owners?
Before we get started, an impatient reader would want me to define “long term.” That is precisely why I wrote this piece. I have not seen rigorous definitions or measures of that term in the financial press. But please wait till section 3.0 for rigorous measures of what “long termism” could mean. Till then, trust me and carry on.
1.0 Difficulties of holding long-term active portfolios
Holding an active portfolio for a long time entails several difficult tradeoffs. The asset manager should ideally really get to know management of the company. To understand a company, you have to understand the firm’s fundamentals (and actually read a 10-K, my pet peeve) and go beyond ratings, scores and other such dubious recommendations of financial intermediaries. The long-term active holder has to invest a lot of time and energy in understanding the firm’s corporate culture, without which the long termer will never get a grip on the operations and intangible value driving future cash flows of its investees.
On top of that, the long termer hopefully votes to maximize long term firm value in the proxy proposal process, negotiates compensation arrangements for the managers of these long-term funds to encourage long- term thinking and less churn in portfolios. In the process, such a long-term vision hopefully influences the compensation contracts of the CEOs of the firms that these long termers own to discourage short term temptations to goose up stock prices or earnings.
2.0 Isn’t active long-term holding the ultimate ESG investment?
I have written earlier that Warren Buffett was against ESG, but looking back, there may be an alternate lens through which to understand his ESG stance. Isn’t investing for the long term in reality the best way to internalize ESG concerns, today’s topic du jour? That might explain why Warren Buffett, a public skeptic of ESG, is perhaps the truest exponent of the long-term thinking underlying ESG. By investing for the long haul, one has no choice but to take into account stakeholders’ interests, such as those of suppliers, employees, and customers, without having to puzzle over ESG scores that claim to measure such a proclivity. What about engagement with management that ESG folks like to talk about? By owning a small set of companies for the long run, aren’t you inherently engaged with managements of those companies?
I set out to understand whether such asset managers exist and what their own governance arrangements look like in practice. Note that this is a long journey with many angles. Hence, I intend to present the data I uncovered in parts. In this part, I am simply trying to understand who the long termers are and whether they make money, as in, beat a passive index.
3.0 Who are the active long-term investors?
How does one identify a long-term investor? The brain-dead answer would be to look at how long the asset manager holds the stock of a particular company. But that metric can mislead. What should we do with asset managers that mostly rely on index funds and ETFs? They hold individual companies, sometimes for long periods, but barely have the time and money to engage with company management in a meaningful way. On the other hand, we have activists like Trian and Elliott, who hold the stock for a year or two, but arguably have more impact on managerial practices than funds that hold the stock for many years. I’ll come back to these points later.
For now, let’s exclude primarily passive vehicles such as ETFs and index funds. Next, exclude funds that are effectively closet indexers. That is, funds that claim to be active but largely mirror what the indexes do. Sticking with active managers, is there a useful summary number that captures their long-term philosophy?
One idea is to consider the average number of quarters for which an asset manager holds its portfolio. The academic literature measures a more sophisticated version of the “duration” of the portfolio as the weighted-average length of time that the fund has held equities in the portfolio over the last five years (weighted by the size of each stock position). That is, if the fund holds a small stake for long, that will increase duration measure less than a large position held for longer. An alternative measure, available only for mutual funds, is the ratio of total buys or total sells divided by the total net assets at the beginning of the year.
Research suggests that the average duration for which a mutual fund holds an individual company in its portfolio is only around 1.3 years, as per Cremers and Pareek (2016)! No wonder funds have no real incentive to monitor management. Neither does management have any incentive to listen to a fund that will be gone by next year. So, who are the real long-term owners?
My soon-to-be-colleague, Kalash Jain, excluded indexers (both real and the closet variety that don’t say they index but do) and crunched the numbers by aggregating all the form 13-F holdings of all stocks held at the fund-family level. I also requested that he exclude banks as they tend to show up as long-term holders in the data without much diagnostic value because they are essentially custodians of such equity. He shared the list of the top 10 long-term investors with the longest time-horizons, with an average duration of about 30 quarters, as of 2018Q4 (the last quarter of his sample), which can be seen below. There are some well-known long-term funds, like Putnam and Gabelli. Berkshire Hathaway is in the top 50, but not in the top 10.
