September 30, 2015

Observations on Short-Termism & Long-Terminsm

Here’s an excerpt from a piece by Finsbury’s Chuck Nathan entitled “Observations on Short-Termism and Long-Terminsm”:

The fourth fallacy in the short-term—long-term debate is that, given every company’s finite resources, choosing a corporate strategy that can be implemented in a relatively short-time period (often a type of so-called “financial engineering”, such as a major stock buyback, a divestiture or spin-off of a business or a sale of the entire company) almost certainly prejudices, if it does not preclude, longer-term more beneficial strategies (such as greater investment in R&D, upgrading productivity of plants and equipment or acquisitions). This formulation of the debate associates activist investors with short-term strategies at the cost to the company and its other shareholders of greater long-term value creation.

But this formulation of the debate simply does not make sense. Activist funds are in business to maximize value creation for their investors (and for their principals who get rich on their carry and their investment in their own funds). Why would any rational activist investor consciously forgo the higher net present value of a long-term company business initiative in favor of the investor’s lower short-term value creating idea? Activist fund managers don’t get paid for ego trips; they get paid for maximizing returns. The same, of course, is true for all actively managed institutional investors. Even index and other quantitative investors should opt for the highest net present value creator if they have the capability of understanding and evaluating the competing proposals. In theory, only short sellers should oppose the highest net present value added program regardless of its duration.