Many fund managers talk about investing for the ‘long term’, but very few stick to it over the course of a full economic cycle. At a time when fewer managers are beating their benchmarks and demand for passive funds is growing, we believe that ‘time’ remains one of the best tools a manager can use to generate alpha – returns over and above the return on the market.
We live in a world that is increasingly driven by the need for immediate returns, and this shines through in stockmarket behaviour. Most investors seem so focused on the here and now, particularly on the next quarter’s earnings results, that they neglect the longer run.
This can result in big inefficiencies in the market, creating opportunities for those who can take a genuinely long-term view on a company.
For bottom-up stock-pickers like us, who focus on trying to find companies that can outgrow the market over the long term, time is a vital component to success. We’ve held four of our top five positions for more than ten years.
Often the key investment drivers that have the greatest long-term impact on a company – such as expansion into a new market, a cost-cutting programme, or the launch of a new product – require many years to play out.
Take, for example, Hugo Boss (Dax: BOSS). The company is trying to accelerate its growth in new markets, such as China, where the brand is clearly under-represented. China currently accounts for around 8.5% of sales, compared to nearer 25% for most of Boss’s key peers.
The group is now doing all the right things in Asia by dramatically increasing new store openings, taking back full control of its store network and ramping up marketing spending in the region.
Even with these measures, it is likely to take at least four to five years to grow the Asian contribution to sales significantly. To capture the benefits of this, an investor must be prepared to take a long view.
A second advantage of long-term investing in a market obsessed with the short term is the benefit of being able to use market volatility to build or reduce your holdings. For instance, in certain industries earnings are susceptible to volatility around particular key projects or contracts.
As a result, the accounting treatment of a project – such as whether a profit is recognised on 31 March or 1 April – can either make or break a particular quarter’s results, leading to big share-price swings. For the long-term investor, such short-term-driven price swings present great opportunities to buy in and benefit from periods of market irrationality.
Another stock that illustrates the need for patience in investing is Diageo (LSE: DGE). The UK drinks company owns brands such as Johnnie Walker, Smirnoff and Baileys.
Diageo is a company we have been following closely for several years, due to its best-in-class product portfolio, the potential for profit-margin growth, and its ability to grow these brands into new markets.
However, the valuation had always appeared to offer little upside to us, preventing us from investing. But after a period of underperformance, the stock has de-rated strongly relative to both the market and peers, and we have been able to buy into the stock without paying the valuation premium you typically associate with a company of Diageo’s quality.
This premium will eventually return, but the case highlights the merits of patience, both during the investment period and prior to investing. Success comes to those who wait.