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Patient Investing Pays Off: Long-Term Fund Managers Show Superior Returns

A new study reveals that mutual fund managers who take a patient, long-term approach to investing tend to outperform their peers who trade more frequently. The research, published in the Journal of Financial and Quantitative Analysis, introduces a new way to measure fund managers’ investment horizons and demonstrates that those with longer holding periods achieve better risk-adjusted returns.

“Stocks largely held by long-horizon funds outperform stocks largely held by short-horizon funds by more than 3% annually, adjusted for risk, over the following five-year period,” explains Russ Wermers, finance professor at the University of Maryland’s Robert H. Smith School of Business and one of the study’s authors.

A New Way to Measure Investment Patience

Wermers and his colleagues developed a unique metric called the “Holding Horizon” (H-H) measure, which examines how long mutual fund managers typically hold their stock positions. The study found striking differences in investment approaches – funds in the shortest holding period quintile averaged just 1.1 years per position, while those in the longest quintile held stocks for 4.8 years on average.

This variation in holding periods appears to matter significantly for performance. The research shows that funds with the longest holding horizons achieved positive risk-adjusted returns of 7-9% over five-year periods, outperforming short-horizon funds by 5-12%.

Understanding Superior Performance

The study suggests that patient fund managers succeed by developing deeper insights into companies’ long-term prospects. They appear particularly skilled at identifying firms with strong long-term fundamentals and cash flow generation potential.

“Our evidence indicates that these long-horizon funds use their insights about firms’ future long-term fundamentals to forecast stock prices,” the researchers write. The findings challenge the common perception that more active trading leads to better returns.

Implications for Individual Investors

For individuals investing in mutual funds through retirement plans, the research offers valuable guidance. Many people rarely adjust their investment selections once made – a behavior that aligns well with choosing longer-horizon funds.

“If an investor in such a plan prefers actively managed funds, they can benefit from selecting long- rather than short-horizon funds,” notes Wermers, who serves as director of Smith’s Center for Financial Policy.

The Client Connection

The study also found an interesting relationship between fund managers’ approaches and their investors. Long-horizon funds tend to attract more patient investors who are less likely to move their money in and out of the fund frequently. This stability allows managers to maintain their long-term investment strategies without being forced to make short-term trades to meet redemptions.

The research provides concrete evidence supporting investment icon Warren Buffett’s famous statement that his “favorite holding period is forever.” While perhaps not quite eternal, the study suggests that longer holding periods – measured in years rather than months – can indeed lead to superior investment results.

The study was conducted by researchers from the University of Maryland, University of Ottawa, and University of New Brunswick, and published as the lead article in the June 2024 issue of the Journal of Financial and Quantitative Analysis.


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