Short-termism is a loaded phrase in debates over investment time horizons, often used to criticize investors and corporate managers deemed overly focused on near-term gains at the expense of long-term value. One argument is that U.S. mutual funds, as significant investors, are preoccupied with quarterly earnings, which feeds the quarterly anxiety of corporate boards of directors. As such, short-termism is a contagion that can spread from funds to firms. Its proponents, on the other hand, highlight short-term investors’ ability to unlock firm value and counter corporate management’s long-term bias.
In a new project, The Long and The Short: Portfolio Turnover Ratios & Mutual Fund Investment Time Horizons, I take neither side in the short-termism debate, but contribute an analysis of 2005-2015 data on U.S. mutual funds’ reported portfolio turnover ratios (PTR)—one measure of investment time horizon. If mutual funds do focus on the short term, their behavior should show up in current and reliable data. With my dataset, I contribute to two foundational inquiries. First, how long, on average, do mutual funds hold onto their assets? Second, how good of a measure is the PTR at approximating mutual fund holding patterns?
Average Mutual Fund Portfolio Turnover Ratios 2005-2015
As to the first question, I find that despite significant fluctuation following the 2008 financial crisis, from 2005–2015, mutual funds’ investment time horizons did not decrease. The average holding period for all funds was in the range of 15 to 17 months, with expected increases for index funds and decreases for other asset classes. My findings do not undercut the claim that mutual fund time horizons are short; they are consistently shorter than historical figures. Between 2005–2015, the average mutual fund PTR was 79 percent, which is in sharp contrast to 26 percent in 1945 and 45 percent in 1975, but lower than estimates from the early 2000’s of 100 to 110 percent. In other words, mutual fund investment time horizons are short, but not getting shorter.
Strength of the PTR as a Proxy for Time Horizons
My findings are only meaningful, however, to the extent that the PTR is a reasonably good estimate of mutual fund time horizons—a conclusion that was not certain at the start of the project. Common criticisms of the PTR include that it provides a flat transaction estimate that does not consider liquidity issues, fund strategy, round trip trades, non-equity asset classes, or rare fund events. It is crucial to note that however flawed the PTR is as a time horizon estimate, it is the only widely available data point. As PTR is the sole indicator of mutual fund time horizons, I was forced to answer the question: How reliable is it as a signal?
PTR Comparisons With Alternative Measures
I compared the PTR data trends with three alternative measures of mutual fund time horizons developed in the finance literature—Duration, Churn Rate, and Modified Portfolio Turnover Ratio (MT)—each of which is mathematically more complex and addresses an underlying criticism levied against the PTR. Regarding the alternative measures, I developed a supporting hypothesis: If PTR provides a valuable signal of mutual fund investment time horizon, then the alternative measures will perform similarly to the PTR and with observable correlations. If, on the other hand, PTR generates trends inconsistent with the alternative measures and without a correlation, this may discount the signaling value of the PTR for mutual fund time horizons.
Three measures— the PTR, Duration, and MT coalesced around an average mutual fund stock holding time of 15 to 17 months. The Churn Rate mean estimated shorter holding periods of 10 to 12 months when averaged between 2005–2015. The Churn Rates, when segmented by fund style, created more consistent estimates of 10 to 15 months, depending upon fund style (i.e., index funds estimated greater than 15 months). Most measures created a consistent story of year-to-year variations, with an observable decline between 2005 and 2015, and an observable impact around the financial crisis. Statistically significant correlations, in the directions expected, between the measures and confirming regressions lend further validation to the PTR measure. A key takeaway from the exercise of calculating and comparing the alternative measures is that mutual funds should continue to report the simple-to-calculate PTR in its annual SEC filings because it is a reasonably reliable estimate
Short-termism Debate: Past and Future
An interesting byproduct of the article is a historical review of the short-termism debate, annotated by key developments such as the outsized role of John Bogle’s short-termism claims, increasing annual turnover rates from the early 2000s, the policy proposals they prompted, and dominant themes that emerged from the academic literature. Before proceeding to the validation of the PTR, I first investigated how people used the PTR as a data point by documenting discussions of it in the Congressional Record, academic articles in law and finance, and industry reports. The historical work tracks the evolution and duration of the short-termism critique and the public’s reliance on the PTR to illustrate investors’ time horizons.
A final note is warranted to justify such an exhaustive review of a seemingly innocuous calculation and to connect this article to my other scholarship. Mutual fund stewardship is not an academic question, it is an inquiry with tangible—even critical—consequences considering that 95 million American invest in mutual funds, primarily as a savings vehicle for retirement and education. Mutual funds manage nearly 22 percent of all U.S. household assets and are major market participants with influence over operating companies. Our fate individually, and as a society, is linked to the security, stability, and stewardship of these private behemoths. All mutual fund investors bear the direct costs of portfolio turnover through transaction fees like commissions and taxes. All mutual fund investors also bear the indirect costs of any negative market externalities generated by short termism. Attention to mutual funds and their oversight is necessary, and it is a task that requires current and reliable data to inform the debate.
This post comes to us from Professor Anne M. Tucker at Georgia State University College of Law. It is based on her recent article, “The Long and The Short: Portfolio Turnover Ratios & Mutual Fund Investment Time Horizons,” available here.