Accusations of investment manager short-termism in UK equity markets are not new. They have been around for years and revolve around perceived over-trading and ever shorter holding periods of shares. This results, so the argument goes, in instability in company share registers and poor returns for clients. The IMA’s latest piece of research, submitted as part of its evidence to the Kay Review, examines this issue in greater detail in an effort to assist the work of the Review as it analyses the UK equity markets.
Our starting point was that to understand investment manager portfolio decisions, you need to ignore the average stock market turnover figures that generate some very low estimates of average holding periods, e.g. less than a year in many developed markets. Why is this? Simply put: investment managers are only one kind of market participant among many others, including high frequency traders. A market average necessarily reflects overall behaviour. Information we have seen suggests that the long-only investment management industry only accounts for 25 per cent of daily UK stock market turnover. The industry’s behaviour needs to be examined separately.
So we looked instead at portfolios specifically managed by IMA members. But here again, there is a need to be careful. Portfolio turnover rates, whose disclosure is required under EU legislation, are frequently used to imply averages holding periods by investment funds. In the case of the UCITS definition of portfolio turnover, a 200 per cent turnover rate is understood to infer that an entire portfolio is changed once in a year. However, this was not the intention of European regulators. While the turnover rate can tell you something about activity within portfolios, it not a reliable measure of holding periods.
For the purposes of the short-termism debate, the interesting metric in our view is not overall activity, but holding periods in individual companies. Once you start to look in more detail at portfolio activity, it becomes apparent that turnover levels are considerably driven by changes in existing holdings, not their liquidation and subsequent acquisition of new holdings. There are a number of reasons for this, notably inflows and outflows; and reinvestment of dividends. Even though portfolio turnover rates are designed to adjust for the effects of flow, they are still only measuring portfolio activity at an aggregate level.
The key questions are therefore how long are companies held in a portfolio; and what is the weight of those companies within the portfolio? Using this approach, we analysed 30 funds which invest a minimum of 80 per cent of their assets in UK equities and found that 71 per cent of companies -86 per cent by their value as a proportion of the fund’s overall equity holdings – had been held for at least one year. Over a longer time horizon, 42 per cent of companies by value within the same sector had been held for at least five years.
There is clearly further work to be done, not least in looking in more detail at whether there is a relationship between the type of company and its holding period. However, our initial findings suggest that investment managers are not inherently short-termist.
Jonathan Lipkin is head of research and pensions at the IMA