Image Credit: Christophe Vorlet
By Jason Zweig | March 22, 2013 6:00 p.m. ET
When you are loyal to a drugstore, airline or credit card, you get points, miles, cash back and other rewards. Should investors also get a bonus for being loyal to a stock?
Next week in London, two dozen global investors will meet to discuss whether companies should offer special shares to reward long-term holders in a short-term world.
Investors who hold a stock continuously for years might earn a higher dividend or receive “warrants” entitling them to purchase more shares.
“It’s a way of rewarding long-term behavior and taxing short-term behavior,” says Patrick Bolton, an economist at Columbia Business School who has spent several years developing the idea.
Patience is a rare virtue in today’s high-speed markets. The average diversified U.S. stock mutual fund holds its typical position for just 15 months, according to investment researcher Morningstar. This past week, Oracle‘s stock lost 10% in a day after the company fell short of quarterly earnings expectations by one penny per share, and shares in FedEx dropped by 9% in two days after a sharp decline in quarterly profits.
Investors with such itchy trigger fingers make corporate managers gun-shy — and that, in turn, might hurt profits in the long run. A survey of more than 400 senior corporate executives in 2003 found that 59% wouldn’t invest in a project that would generate significantly higher long-term profits if it reduced earnings in the short run.
“The assets and employees and customers and suppliers of companies are there for years,” says David Herro, manager of the $14.3 billion Oakmark International Fund. “But shareholders are often there and gone in a week, a day, an hour, a minute. So you have this mismatch, and it’s a bit of an imperfection in the way capitalism works.”
The London meetings follow one in Toronto and two in New York; at least 75 corporate issuers, investors and other financial firms have weighed in.
“We want to see what the market thinks and create enough awareness about the idea that it will either get used or else get modified into something else that’s usable,” says Jane Ambachtsheer, global head of responsible investment at Mercer, the consulting firm, who is helping to organize the debate.
“It’s going to be very difficult to get anything done” in the U.S., warns John Bogle, founder of Vanguard Group, who has long advocated that companies should pay dividends 5% to 10% higher to long-term investors. The response to his proposal, he says, has always been the same: “silence.”
Hayne Leland, a finance professor at the University of California, Berkeley, points out that rewarding long-term investors could drive away short-term traders, perhaps making it more expensive to buy and sell stocks that carry loyalty rewards.
Christian Dior, Publicis Groupe and Sodexo have conferred extra voting rights on shareholders who stick around, typically for two years or more; others, like Air Liquide, Lafarge and L’Oréal, pay bonus dividends.
The fact that these companies are based in France, where capitalism and socialism dance cheek-to-cheek, might make you raise an eyebrow.
So far as I know, no U.S. company offers such rewards. One that used to — Potlatch, the timber company, which starting in the 1980s offered extra voting rights to investors who stuck around for at least four years — later dropped the provision after complaints that it gave insiders too much power. A Potlatch spokesman declined to comment.
David Winters, portfolio manager of the $1.8 billion Wintergreen Fund, calls the idea of loyalty shares “very interesting.” But he warns that it could “become an entrenching mechanism as opposed to a rewarding mechanism” — potentially coercing long-term investors into kowtowing to management.
The renowned investor Benjamin Graham often pointed out that small investors have great advantages over professionals: Individuals can choose not to measure their results over the short term, and they can invest at will in unfashionable stocks.
So you don’t have to have ants in your pants just because everyone else does.
Research by University of California economists Terrance Odean and Brad Barber has shown that investors who traded the least outperformed those who traded the most by a remarkable 6.8 percentage points annually.
So buy an index fund and hold it forever. Or find a mutual fund with expenses under 1% and a turnover rate of 33% or less, meaning it holds its typical stock for at least three years. Or pick a few stocks yourself, buying on bad news and then holding stubbornly through all the short-term noise.
Before you buy, write down at least three reasons why you believe the company is a good investment; sell only if those reasons have become invalid.
“If you are fortunate enough to invest in one of those rare companies that are great long-term investments,” Mr. Winters says, “the best reward is just owning the shares for years on end.”
Source: The Wall Street Journal, http://www.wsj.com/articles/SB10001424127887324373204578376510815675122
For further reading:
A Rediscovered Masterpiece by Benjamin Graham
Chapters One, Eight and Twenty in Benjamin Graham, The Intelligent Investor
Chapter Four, “Prediction,” in Your Money and Your Brain
Patrick Bolton and Frederic Samama: “L-Shares: Rewarding Long-Term Investors”
Brad M. Barber and Terrance Odean, “Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors” (Barber website) (Odean website)
Chapter Twelve, “The State of Long-Term Expectation,” in John Maynard Keynes, The General Theory of Employment, Interest and Money