Playing the long game

Should investors try to time the market? The musings of Terry Smith, the veteran fund manager who is never afraid to speak his mind, are always both entertaining and thought-provoking – and his latest column on this topic in the Financial Times is no exception. There are only two types of investors when it comes to market timing, he suggests: “those who can’t do it, and those who know they can’t do it”.

It is difficult to disagree. The gains available from successfully calling the market are surprisingly small when compared to simply investing regularly – around 0.4 percentage points a year over 50 years to 2020 according to one analysis conducted by Smith. Moreover, the likelihood of consistently getting it right is pretty low - none of us is blessed with perfect foresight – and the downside is potentially sizeable.

So far, so comfortable. But doesn’t this argument undermine the case for investing in the kind of actively-managed funds that Smith himself runs? And, for that matter, investment companies, which are almost always run actively? In the open-ended fund industry, by contrast, the rise of index trackers continues unabated. Why should active managers be any better at calling the market than the rest of us?

The short answer is they’re almost always not. But then they don’t necessarily have to be. In truth, the best active managers invest with something of a passive style. Their convictions take them away from the index, whether it is a liking for a particular stock, sector, theme or market, but they stick with their views for the long term and don’t worry too much about ups and downs along the way.

Warren Buffett, the most famous active investor of them all, is the perfect example. “If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes,” he once said. In another one of those pearls of wisdom he’s known for, Buffett added: “Someone's sitting in the shade today because someone planted a tree a long time ago.”

This is what we want from the active managers to whom we hand over charges that look chunky compared to the fees payable on passive funds. We pay them to make smart long-term decisions – and to avoid being distracted by short-term shifts in market sentiment. We’re looking for good investors, in other words, rather than for clever traders.

This is an idea that many of the most successful investment companies have recognised. Think, for example, of Scottish Mortgage and the long-term faith it has shown in technology companies; its managers haven’t got over-excited by the enormous gains these stocks have made in recent years any more than they despaired when tech stocks were so out of favour. Think of a fund such as Baillie Gifford Shin Nippon, which has showed remarkable long-term faith in the story of Japanese smaller companies, despite some dramatic ups and downs.

This is not to argue that such an approach is the preserve of investment companies alone. But there is something about the investment company structure that is particularly supportive of active investment with a long-term view. Operating as a service provider to the fund and appointed by its independent board, the manager’s role is nuanced; with a supportive board, there is greater room to breathe than in an open-ended fund where the manager is under the pressure of running a product on behalf of his or her employer.

Play the long game, advisers routinely tell their investing clients. Too often, however, fund managers find themselves on the hook to deliver short-term returns. We shouldn’t be surprised when that goes wrong – for all the reasons Smith points to in the market timing debate. Investment companies, on the whole, do a better job of keeping their eye on the long-term prize.