Time Horizon Alignment

In a previous post I discussed the idea of time dilation. Time is not absolute. This idea comes to us from physics, which is a fairly exacting and mathematical discipline. The measurement depends on the relative velocity of the observer and whatever it is she is observing. It’s relative. Hence, “relativity.”

Likewise with portfolio management, the velocity of activity in your portfolio will tend to reflect your investing time horizon. Someone managing money trying to think about what a business will look like in a decade may go entire years without placing a single trade. However, this is unlikely to be the case for someone operating on a one to three year time horizon. Especially if that person is managing other people’s money. And doubly so if the other people whose money is being managed are evaluating performance on a quarterly or annual basis.

The tendency among institutional investors these days is to track performance on shorter and shorter intervals. I follow hedge funds that provide weekly performance estimates. This despite offering quarterly liquidity or less! I haven’t the slightest idea what someone is supposed to do with that information. It’s random noise. (Someday I mean to do a piece on the collective delusions of institutional investment committees)

I am convinced the way you should deal with this is to scale your input data to your time horizon. So for example if you are trying to puzzle out what a business might look like in five or ten years you probably should limit your focus to annual reports and proxy statements (at least once your initial due diligence is done). Even quarterly results are likely to introduce a lot of unwelcome noise into the picture.

What if something material changes halfway through the year?

Well, you can still risk manage the portfolio on more frequent intervals (an underlying assumption here is that you are thesis-driven versus trading on technicals). If something nasty, unexpected and material happens to a stock halfway through the year you are going to see it sell off sharply. That’s the trigger to dig in further to see if the investment is impaired. If you own a good business with a strong balance sheet it is going to decline over a period of years, not months. You will have time to get out before things get catastrophically bad.

Now, this only works with high quality businesses. It doesn’t work with classical value investing. It doesn’t work with merger-arb type special situations. It definitely doesn’t work with distressed investing. I watch value investments much more closely. Also cyclicals. Particularly if there is leverage involved. Levered cyclicals (think banks) can deteriorate very rapidly, and fatally.

So it’s not that a long time horizon is always superior.

It’s that mismatches create problems.

Oh, and if anyone happens to know what those weekly performance estimates are good for, drop me a line in the comments.

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