Do investors think enough about the long term? Certainly, sustainability gets more attention now, but for most investors it is hard to think in decades. Even with shorter company lifespans and longer human ones, the practice of investing remains rooted in the business environment of today. The illusion of control notes that we place too much faith in what we can calculate and our actions, overestimating our influence on complex outcomes. The long term future is an uncomfortably intangible world that investors prefer not to think too much about. Is there anything sensible to do?
Investors could begin by questioning some of today’s solutions. Faced with uncertainty on future investment returns, it looks wise to focus on today’s costs. This has triggered a boom in passive investing, creating high concentration on currently successful businesses. The biggest enjoy a continued boost to their capitalisation, with investment flows apparently self-fulfilling.
It is easy to be blinded by the modern and technological look of companies like Facebook; perfectly evolved for the world of 2018. And its success means that investors can easily reassure themselves by analysing its historic numbers or current market position. But within five to ten years, the business could face many challenges; changing consumer tastes, new disruptive competition, tax changes and the risk of regulatory intervention. Can we be so sure that these companies will evolve to maintain their relevance, winning a claim on a share of the global economy decades ahead?
Some think yield is the answer. But companies with high dividend distributions merely swap some of the longer term risks for the challenge of reinvesting that income. It cuts risk in the long term residual value of a specific stock, but may do little to address the long term challenge across a portfolio. Present bias describes the tendency to over-value immediate rewards at the expense of the long term.
Diversification may help, particularly with a spread of asset classes, but may dilute rather than remove the dangers. However, many thoughtful smaller bets may still beat a blind faith in backing today’s biggest businesses. This could be part of the solution to our pre-occupation with the present.
Some major investors forced to think longer term include the largest pension funds and sovereign wealth funds. Many have not only paid attention to costs and ticking ESG boxes, but have also added to alternatives. Infrastructure value typically spans decades, but still involves political risk, tax and macro factors. Real estate may behave similarly. We should not be confident that the best long term investments are even listed on today’s stockmarkets.
Now, earlier-stage private equity is gaining increasing attention. Active investors have noted that many capital-lite businesses only IPO as their growth rate slows. One sign that more thought is being given to the long term, may be the increased attention that active investors are giving to small and mid-caps, and private equity. We can expect more crossover investing spanning public and private markets.
Investing in today’s biggest companies for needs that must be delivered in the middle of this century is questionable. The human brain draws comfort from what can be measured today and shies away from tough thinking about tomorrow. A tick-box approach to ESG may just give false confidence. Making today’s businesses sustainable is not the same as ensuring that they will be around in 30 years – it is an illusion of control. And today’s biggest capitalised companies are essentially yesterday’s winners. Many of tomorrow’s successes are still unquoted, spending longer than ever in private hands.
Nice, “sustainable” companies get disrupted, too. Some of the most socially responsible businesses of last century were companies like Cadbury and Rowntree. Now their acquirers are not even sure whether sugar is a business for the future. An investor focus on environmental, governance and sustainability factors can add value to an investment process today, but it will not guarantee that a business will actually adapt over time.
Effectively, low attention to the future is hyperbolic discounting - surprising at a time of low interest rates. But it does reveal greater uncertainty about the future in a world of disruption, populism and global tensions. There may be no single solution, but a good start is to recognise human fallibility as we over-think the present.
Disclaimer: At the time of writing, SVM and its clients do not hold positions in any of the companies mentioned in this article.
A version of this article was published on Citywire on 23 October 2018.