Warren Buffet was once asked what sort of typical holding period he and his Berkshire Hathaway clan liked for their investments. “Our favourite holding period is forever”, he replied. With that simple concept in mind, we can begin to understand what has led to the Sage of Omaha topping the world’s rich lists. He is an “investor” in the truest sense of the word, taking an active interest in the sales of widgets, cans of diet coke, or whatever else the portfolio of companies he owns do their daily trade in. He can be separated from many would-be “investors” who roll their dice day-in day-out on global capital markets, hoping to make a quick buck or million. In many cases these punters have little or no vested interest in the operational performance of the underlying companies that keep our economies ticking. This doesn’t necessarily stop them making money, but it’s certainly questionable as to their value add in making the world tick.
Over the past few years as technology has leapt forward this set of “investors”, though, has become incredibly important. The speed at which capital moves around the system can make or break companies in short order. Many of these companies are perhaps destined to fail – but the lack of basic understanding of the fundamentals of companies that these “investors” are equipped with often can turn a bad headline or rumour into panic selling, or vice-versa on a hunch or whim. While its true that more participants in global capital markets is good for liquidity, it’s not necessarily good from a transparency perspective or in terms of reducing uncertainty. It’s a bit ironic that investment banks and brokers love uncertainty and volatility, and they profit most during these times, yet their biggest clients hate it and really struggle when their future funding or relationships with suppliers is up in the air.
At its core capital markets is simply about the interaction between people who need money, to carry out business plans, and people who need to put money to work, pension funds and the like. A good capital market will take capital to the places where the best returns are to be found, and to business that create products that people want. What is great is that these trades between participants can be mutually beneficial. Warren Buffett believes in that process and understands how he can benefit from it working effectively, and so do the companies that benefit from his investment.
The financial crisis has revealed that markets can appear to favour speculation over long-term ownership – hence Washington and London’s recent investigations into curbing speculation in the oil markets. It has also revealed that equity sometimes is not as solid as it might appear – hence the banking crisis. There is now doubt that restoring confidence in the system will require investors who take more than just a passing interest in the long-term health of the companies they own. The question for policymakers is how best to encourage this.
The separation between these two types of participants in global capital markets has come into focus in the UK this week. Gordon Brown’s City Minister, Lord Myners, has been mulling over proposals that will reduce the speculative nature of stock market investing, and encourage a focus on the longer term. One of the proposals he has put forward is a two-tier shareholder structure, whereby longer term holders of shares would have increased voting rights. He said: “There is a lot of evidence to suggest that most institutions are uncomfortable with the responsibilities of ownership as opposed to investment. We need to fix that, otherwise we have ownerless corporations.”
From my perspective, I applaud the mindset that Lord Myners is bringing to bear. He is clearly trying to advocate the Warren Buffett school of value based investment. The solution to this policy dilemma is not straight forward, however. Set aside the practical matter of defining what is meant by long-term versus short-term investors – a tricky and arbitrary process. Blow-ups in Europe – such as Porsche, with its complicated system of preference and ordinary shares – suggest that two-tier systems wouldn’t be a universal solution. Europe’s experience suggests that having two tiers of shareholders leaves second-tier investors captive to forming potential destructive shareholder cliques that wouldn’t solve the bigger problem.
As the Lex column in the FT pointed out this week – it is far better for policymakers to focus on market-based incentives. One might be tax relief on dividends. A shareholder who bought and held a company’s stock for five years, say, might see the tax rate on his dividends gradually decline to zero. Once a share was sold, the clock on the tax benefits would re-set rather than be transferred to the new owner. As the FT commented: “That would represent an improvement for all stakeholders, as it would encourage long-term shareholders while also discouraging shares being used as vehicles for ramping and short-term speculation.”
Again that solution seems like a pretty good one, but it might throw-up other unintended consequences (it would certainly create some lucrative work for creative tax lawyers). It’s not clear to me what a perfect solution would be, and there probably isn’t one. But on the positive side, it is good to see that this sort of discussion is taking place as the recovery process depends on readjusting the whole financial system to a longer term outlook.