What kind of investor are you?

Stephen Wilmot

What's the difference between a speculator and an investor? One reliable answer is that it lies in the rhetorical intentions of the person making the distinction. Those wishing to cast market activity in a dim light – usually because it pushes up the financing costs of the country or company they run – use the word speculator; those preferring to remain neutral or positive opt for investor.

But this is a bit glib: the words are not all about spin; the differences they conjure up do exist. For some, the London Stock Exchange is a casino – a game at which to win is to profit. For others, it is a warehouse – the least bad place they can find to park their earnings for long periods.

Rebecca O'Keefe of Interactive Investor, an execution-only stockbroker, reckons about half her company's clients are "traders" (a polite word for speculators) and half are "investors". She splits each group into two. Half the traders buy and sell just one stock, typically volatile ones – Gulf Keystone (GKP), Quindell (QPP), Blinkx (BLNX), Xcite Energy (XEL). "You can be guaranteed they know more about their one stock than anyone else," she points out.

The other traders confine their activity to one sector, often oil and gas or mining. Hunting down ten-baggers in junior mining was not, it seems, purely a bull-market phenomenon; Ms O'Keefe says interest in the sector has continued since the resources boom peaked some three years ago. That underlines the importance of short-term volatility rather than long-term returns to trading strategies.

As for the "investors", about half are slightly more active, with portfolios of typically large-cap shares, traded periodically. The other half are buy-and-hold investors who monitor their portfolios only every three to six months and very rarely sell.

This typology of private investors is interesting – not least because it lays bare the extraordinary range of ways in which people use the stock market. But it is not entirely typical. On average, Interactive Investor's clients make about eight trades a year. The wider execution-only market is only half as active, with an average of 1.03 trades per nominee account in the final quarter of 2013, according to market research firm ComPeer. Nearly four-fifths of account holders did not trade at all in the quarter. "You get a small number of people who do a lot of deals," explains Guy Knight, sales and marketing director at The Share Centre.

Long-term investors tend to survey traders from an assumed moral and intellectual high ground. There are good reasons for this – even if there is no clear water between the two categories, and many probably fit into both camps. Economist John Kay's review for the government into “UK equity markets and long-term decision making” in mid 2012 is a masterful analysis of the problems associated with disengaged, short-term share ownership.

Professor Kay argues that short-term investing fosters short-term company management. This is manifested in a "tendency to under-investment, whether in physical assets or in intangibles such as product development, employee skills and reputation with customers", as well as in "hyperactive behaviour by executives whose corporate strategy focuses on restructuring, financial re-engineering or mergers and acquisitions at the expense of developing the fundamental operational capabilities of the business".

There is a parenthetical parallel here with political culture. Just as ministers are too worried about approval ratings and the next election to make long-term decisions about infrastructure or defence procurement, so managers are too worried about share prices and quarterly profit numbers to invest in the long-term health of listed businesses. The common problem, perhaps, is the glare of publicity.

Of course, traders are doing no direct harm to the system. If you have found a short-term strategy that makes money, it would be silly to ditch it in some vague effort to support better corporate governance. But the nub of Professor Kay's reflections – which trace a single path from the failure of old stock-market stalwarts ICI and GEC in the early 2000s via the banking collapses of 2007-09 to the Deepwater Horizon disaster at BP – is that the long-term approach turns out to be better for shareholders.

This is one reason, incidentally, why this magazine has always been keen on family-run businesses. A major, permanent stock holding by the managers – companies like Town Centre Securities (TCSC) and CLS Holdings (CLI) spring to mind – is probably the best safeguard stock pickers can find against executive short-termism.

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