Dissing Shiller, etc

I've mentioned Paul Marsh's 1990 report on short-termism a couple of times. It is definitely worth a read as, even if you disagree with some of the conclusions, it's actually a much more meticulous assessment of the arguments than many more recent short-termism reports.

It's interesting to note in passing that Robert Shiller gets a bit of a slap. This was pre-Irrational Exuberance, when he was more interested in volatility, though with hindsight you can understand why he ended up where he did. Anyway, here's Marsh's put-down:

[S]ome researchers have moved away from a fcous on trading rules, and instead have devised tests for "excessive volitility". The best-known work here is by Shiller (1981) who claimed that stock market prices were far more volatile than could be justified by the much lower volatility of dividends. Subsequent researchers, notably Marsh and Merton (1986), have shown that Shiller's analysis is fundamentally flawed, since it ignores what we know about the way that managers decide on dividends, namely that they try to "smooth" them out over time.

I think that's fighting talk!

Separately, I thought I would flag up a bit I disagree with, which is this:

Faced with the demand for better short-term performance, the fund manager... cannot sell the future short. The only way he or she can outperform is to identify undervalued shares and buy them, and/or overvalued shares and sell them. This, however, can be achieved only through careful investment analysis of a company's short and longer-term prospects - something widely held to be a good thing.

I don't disagree that this is what ought to happen, rather I think that in certain circumstances short-term pressures may lead to "careful investment analysis" getting skewed to result in the picking of stocks that seem to be heading up regardless - see the TMT bubble.

Notably Marsh's report, which - as should be obvious - I like, was commissioned by IFMA (the old name for fund management industry's trade body). Post the TMT bubble EAMA (the European equivalent) commissioned a series of essays on what just happened. Compare and contrast this excerpt from one of the pieces in it:

When Vodafone acquired Mannesman, many investment managers took the view that it made sense to increase their holding even though they believed the shares to be expensive and likely, eventually, to fall in value. The same managers became ever more likely to invest in TMT stocks the more expensive they became. Why? Because to be underweight in these investments without the certainty of being proved right, created significant business risks if the impact on short-term relative performance was serious and if the Principal took a dim view of the way his funds were being managed. Failing conventionally when managing a portfolio can sometimes lead to an acceptable outcome for an investment manager’s business.

If you're interested the piece is by Chris Cheetham, former chief investment officer at Axa, now at HSBC I think. The collection of essays is called Boom and Bust: The equity market crisis - lessons for asset managers and their clients.