The Globe and Mail, Report on Business
Published February 7, 2009

I've been having trouble sleeping, so I dusted off a research report written by my friend, J.J. Woolverton, who is the chairman of Guardian Capital LP (he makes me read these things). The report was called Performance Inhibitors (or The Seven Deadly Sins).

Before your imagination gets carried away with the title, this is a heavy-duty treatise aimed at institutional investors. It goes through seven factors that “have the potential to materially impact overall performance results.” I was almost asleep when I came to Deadly Sin #3 — time — in which he discusses how the multitude of players involved with a pension plan all have different time frames.

The plan itself may have a time horizon of more than 40 years, while the investment committee is looking out five-to-10, the investment manager is at four (J.J.'s optimistic view), the actuary one-three, and so it goes.

Sin #3 speaks to one of the great disconnects in our industry. We are managing assets to offset liabilities that are 15 to 40 years away, and yet all the inputs and strategies that go into our process are short to medium term in nature.

We hold five-year notes rather than 25-year strip bonds that would more closely match our investment horizon. We trade our portfolios based on short-term expectations rather than long-term value creation.

All that would be fine, and indeed not a sin, if short-term focus produced good results, but it doesn't. If we are interested in making educated guesses and finding bets that are stacked in our favour, which we are, then short-term timing is the most difficult way to add value and produce superior returns. How much of an edge can we develop when everyone is trying to figure out what a stock, or the market over all, is going to do next? Our sandbox gets pretty crowded.

David Swensen, chief investment officer of Yale University, said: “Stock pickers hoping to beat the market quarter in and quarter out accept a formidable challenge. In attempting to find securities with both material mispricings and near-term triggers... the money manager places substantial limits on the available choices. Operating with a longer investment horizon increases the opportunity set of choices, dramatically improving the odds of creating a winning portfolio.”

So if time frame is such a huge issue for investors, both professional and amateur, why do we keep focusing on the near future? Isn't this a structural inefficiency that a smart investor can exploit? The answer is yes, but it's really, really, really hard to do.

Even when we start out with an objective that is aligned to our needs — above-average returns over the next 30 years — we immediately start executing a plan using short-term inputs.

We ask questions like, “When should I get into the market? What's going to do well this year? What sector should I rotate into?” and then base our decisions on the answers.

Even those of us who don't ask the questions, too often allow ourselves to answer them. It's hard not to, because that's what we talk about in this business.

It's particularly hard because the information coming at us each day is short term in nature. The media is focused on yesterday's news and what the next week or month will bring, which is their job.

The financial analysts are looking further out, but the requirement to estimate quarterly earnings also keeps them focused on the here and now. Too many words are spent discussing whether Shoppers Drug Mart “met expectations” as opposed to whether its cosmetic and generic initiatives are enhancing its market position. I can't think of a bigger waste of brainpower.

Indeed, the reporting cycle, or feedback loop, for the whole industry comes around every three months. Companies report their progress to the Street, analysts assess the numbers and update their recommendations, and advisers and money managers report back to their clients on what's happened since last time.

The scary thing is that the investment business entrenches the short-term focus. Compensation drives behaviour and there are still too many professionals who are paid bonuses based on how they did over the past 12 months. Who are we kidding? If a manager's decisions are based on long-term considerations, then one-year performance is virtually random.

If you're waiting for a punch line to this column, there isn't one. I don't have a list of tips. I believe thinking long term will lead to better results, but it isn't a silver bullet. There will be years like 2008 when looking ahead causes us to miss a pothole that is lurking below our headlights.

One thing I do know for sure — successful money managers have long since let go of the notion that they can time the market.

And speaking of time, I'd better get back to the matter at hand. Hmmm... Sin #4 — committees — that ought to do it.