History shows that investing in companies with apparently good long-term prospects doesn’t pay on average. The simplest indicator of a growth stock is its valuation; stocks that are perceived to offer higher long-term cashflows should be on lower dividend yields. But such stocks tend to under-perform. For example, in the last 20 years the FTSE 350 low yield index has given a total annualized return of 6.3 per cent, against 8.8 per cent for the FTSE 350 high yield index. This is consistent with earlier evidence, that value beats growth around the world. It’s also consistent with the fact that another “long-term” asset class – private equity – has also delivered only mixed returns.
There’s a reason for this. The longer your time horizon, the greater is the uncertainty facing any individual company; for the next two or three years, you’ve probably got a fair idea of the SWOTs of companies you follow. But on a 10 or 20 year horizon, you haven’t a clue, because we can’t predict the pace and direction of long-term technical change and hence the winners and losers from creative destruction. This irreducible uncertainty means we know less about future corporate growth than we think we do, which in turn means there’s a good chance that companies which we expect to offer long-term growth will disappoint us and so under-perform the market.
I’d add that this danger is even greater in the next few years. If – as I suspect – long bond yields return towards more normal levels, growth stocks could do badly as the discount rate applied to long-term cashflows rises.
A portfolio that is, “resilient in the long-term” would be a passive tracker fund – because this backs the field rather than any particular horse, and so minimizes exposure to long-term company-specific uncertainty. (It would also dispense with the need for equity analysts and so reduce fees.)
This, though, isn’t the only sense in which the Prince claimed that long-termism is better. He suggested that attempting to beat the market in the short-term “is a recipe for doing badly in the long-term.” This is plausible. We know – thanks in part to the work of Robert Shiller – that there can be long-term predictability in aggregate share prices; the longer the time horizon, the better the correlation between (say) dividend yields and subsequent returns. A short-term, investor, however, fails to exploit this fact, and instead can be misled by short-term noise.
But are the few investors who are strong enough to exploit this long-term predictability really ones His Royal Highness wants? I fear not. Back in early 2000, a long-term investor would have been out of technology stocks and invested in higher yielding ones. But these were the tobacco and mining stocks that would probably fail the Prince’s test of meeting “environmental and social challenges.”
He might be confident that the world faces a “gathering storm” caused by pollution, over-consumption and catastrophic climate change, but many of us are less certain about what the future holds. Such uncertainty means that our investment strategies must be tentative. Maybe it would be better for the world if pension funds invested more in green projects. But it wouldn’t necessarily be better for their clients.
