The advantages of patience

“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” So says Warren Buffett, the renowned investor who has persistently pleaded the case for long-term investment – “our favourite holding period is forever”, he’s also said.

It’s advice that professional fund managers routinely ignore, very often to the detriment of investors. The Investment Association said last year that the average portfolio turnover rate across equity funds managed in the UK is around 40 per cent – in other words, in a given year the typical fund manager sells four out of every 10 holdings in the portfolio. That means the fund isn’t securing the long-term value for investors presumably hoped for when these holdings were acquired in the first place – plus it is incurring transaction costs that reduce returns.

If this sort of short-termism is bad news for investors, it also does no favours for the portfolio holdings that are constantly bought or sold. Short-termism is problematic for large companies, which all too often feel compelled to focus on the here and now to appease investors, rather than planning for the long-term. And for smaller companies still building for growth, it’s really bad news since fund managers aren’t prepared to support them with the capital they need when there may be no pay-off for many years to come.

This issue has reared its head time and again in the UK – most recently in the Treasury-backed investigation into patient capital that reported last week. It concluded, like several investigations before it, that the UK isn’t good enough at funding small and medium businesses as they grow and develop.

How, then, to solve this problem? Well, contained within the Treasury report lies an important observation that at least part of the solution is already in place. “The creation of more listed funds could support the review’s overall aim of catalysing greater effective investment in patient capital,” the report says.

What we’re talking about here is investment companies. The closed-ended structure of an investment company gives its manager much greater freedom to retain favoured holdings for the long term, rather than selling out during difficult times, or periods of share price volatility. With a fixed number of shares in issue, the manager does not have to worry about ebbs and flows of investor capital – there is never a need to sell holdings at knock-down prices simply to meet redemption calls.

You can see these benefits in practice in several areas of the investment company industry, where funds are providing exactly the sort of patient capital that growing businesses need. The listed private equity fund sector, for example, backs such companies with billions of pounds of funding. The venture capital trust sector has now been an important source of patient capital for more than 20 years. Elsewhere, investment companies such as Neil Woodford’s Patient Capital Trust have been launched to exploit the advantages of this structure.

For investors, the long-term returns from such vehicles are often enticing, even if short-term volatility may sometimes be greater. For the businesses the funds back, moreover, their cash provides crucial firepower to support the ambition of founders and management.

The Treasury is right to recognise the potential of listed funds to provide the patient capital the UK requires. Now it must rise to the challenge of providing greater support for these vehicles in the future. There’s no need to reinvent the wheel when so many investment companies are doing such a good job already.