To have and to hold – that is the question

23rd September 2010

There are plenty of advocates of buy and hold with one of the most successful being Warren Buffett, who has demonstrated that he has the skill to actually pull it off.

There's no doubt that it is he simplest of investment approaches. You buy good quality companies that are undervalued by the market and then hold them for the long-term. The idea is tha those who can do this should be rewarded by a capital gain and a rising stream of dividends. 

An excellent paper (opens in PDF format) on this whole area of patience and finance has just been brought out by Andrew Haldane, the Bank of England's executive director for financial stability.

He makes lots of interesting observations, one of which is that the average time that investors hold UK shares has fallen from five years back in the 1960s to around seven-and-a-half months by 2007.

This implies a much greater use of short-term strategies, which is probably largely because of the growth in the size of the hedge fund sector.

Malcolm Wheatley writing on The Motley Fool believes that Haldane's paper contains a very different message for investors. His interpretation is that wisely-chosen shares held for the long-term will deliver exceptional returns.

Do professional investors ever just buy & hold?

Nick Kirrage, who co manages the Schroder Recovery Fund, says that they are investors with a three to five year view or longer. This keeps the turnover – and transactions costs – to a minimum. Last year it was only about 3%.

"As value investors we can ensure that we are paying less than intrinsic value for a stock, but we have no control over how long it will take for other investors to appreciate this. Consequently, it could take years before an investment is rewarded."

One study estimated that a group of the most successful US value investors had an average holding period of five years, while for the average US mutual fund it was just one year.

Kirrage explains that the true value of a company is determined by a lifetime of profits, encompassing both good times and bad.

"To capture this, we normalise profits, identifying the levels of returns that can be generated in a normal, or mid-cycle, economic environment. This allows us to exploit the market's myopic focus on the short term, to buy a long term cheap asset."

Applying a conservative multiple to the normalised profit stream enables him to come up with a target price. He will then look to sell the holding as the shares approach this level.

Long-term view

It is a similar story at Henderson Global Investors where the turnover in the funds is typically around 30% per annum, which is relatively low by industry standards.

Graham Kitchen, their deputy head of equities, says that they always buy for the long-term with a valuation target in mind. "The timeframe can vary and might take a couple of years, but if you buy fundamentally cheap stocks there is no need to keep turning over the portfolio."

Generally speaking they will only look to sell a stock if it increases as anticipated and becomes fully valued, or if something happens to undermine the fundamentals. 

"There are only two things that drive share prices: the returns the company achieves and the valuation. It is these two fundamental factors that we concentrate on," explains Kitchen.

The Gartmore approach

Ben Wallace and Luke Newman, senior investment managers on the Gartmore UK Absolute Return Fund, believe it is a combination of both fundamental analysis and tactical awareness that generates positive performance.

About a third of their portfolio is made up of core holdings that are typically held for around a year. The balance comprises shorter term tactical exposures, which are more likely to be in the fund for three months.

"With the core positions we are looking for earnings growth above that reflected in the share price, while the tactical holdings aim to take advantage of factors influencing stock prices over a shorter time frame."

On their tactical positions they automatically use a 10% stop-loss, whereas on the core book they don't use them mechanically, but often behave as if they do in order to limit losses.

Leigh Himsworth, head of UK Equities and manager of the Gartmore UK Growth and Gartmore UK Alpha funds, has a similar approach.

His portfolios are a mixture of long-term holdings where he's looking for a significant change in the fundamentals and shorter-term positions where he wants to capitalise on near-term catalysts.

"I try to always bear in mind that a fund manager's primary responsibility is to the investors in their fund and aim to deliver the return that they want. This means the potential upside of an investment has to be viewed in terms of the time horizon it will take to get it," he says.

In the case of new company management the change may take three years to come to fruition, in which case he would want to see at least 50% upside from the current price.

"If there was an event that was expected to take place within a month that would be a catalyst for change like a takeover or results announcement, then a rise of 10% could be very attractive. Both approaches can work but they are different situations."

Passive funds

One set of funds that uses buy & hold almost by default are the index trackers.

ETFs only have to re-balance when their benchmark changes, although passively managed unit trusts and OEICs also have to continually adjust for client inflows and outflows.

David Chellew, head of UK wholesale marketing at HSBC, says that actively managed funds with high stock turnover generate a lot of costs on top of the annual management charge and this eats away much of the expected return.

"The additional costs and risks of a high turnover approach are quite significant and reduce the probability of long-term success. That is why a lot of pension schemes invest in passive funds."

The evidence suggests that it's hard to beat the indices in some of the more developed markets like the US. This implies that in these areas investors would be better off using the buy and hold approach of index trackers and then adding value through tactical asset allocation.

"Buy and hold can work if your approach to asset allocation matches your risk perspective. The question is whether you expect to generate your returns from asset allocation or stock selection," explains Chellew.

The lessons for fun
d investors

Whatever sort of funds you invest in it is never safe to assume that buy and hold will always deliver.

Martin Bamford, MD of IFA Informed Choice Limited, says that it's important to review your investment portfolio at least once a year, in terms of both overall asset allocation and the individual funds you hold.

"Investors with larger portfolios, or those who want to take a more active approach, might implement this formal review once every six months, or even quarterly, but the vast majority of people can achieve their objectives with a thorough annual review."

When evaluating individual holdings investors need to check that the funds continue to meet their requirements in terms of performance, management style, objectives and mandate.  

"There is a great deal of apathy out there. Investors should be more proactive when it comes to sacking funds and replacing them with more attractive alternatives," advises Bamford.

He makes the point that people should never leave underperforming funds or those that have lost direction languishing in their portfolios. This is especially the case given that modern investment platforms make it quick, cheap and easy to switch one fund for another. 

Leave a Reply

Your email address will not be published. Required fields are marked *