It isn’t hard to see that finance has drifted from its core purpose: the thoughtful long-term use of clients’ money in real-world wealth creation. Instead, what we now call investment has advanced to a mathematical pseudo-science, Stuart Dunbar writes in an essay for finews.first.

This article is published on finews.first, a forum for authors specialized in economic and financial topics.

As a large investor in listed equities all around the world, it may come as a surprise to some when we say that we’re really not very interested in stock markets. Sure, markets need a mechanism for providing liquidity between investors with different perspectives and time horizons.

But the daily gyrations of share prices are a distraction which, in the main, we should ignore. Trading in secondary markets may create winners and losers, but not investment returns.

«This creates a real opportunity»

It’s not hard to observe that our industry has drifted further and further from its core purpose – the thoughtful long-term deployment of our clients’ capital into real-world wealth creation. Instead, what we call «investment» has become a mathematical and pseudo-scientific exercise in analyzing the behavior of share prices and asset classes against their own history and other shares.

One massive game of relative valuations, or what I like to term «Squabbling Over Returns» rather than creating them. This creates a real opportunity for fundamental managers to offer something truly differentiated for investors.

«The investment industry should be better than this»

The investment industry should be better than this, both for our investors and for society. At the most basic level, we need to work constructively with the management of companies as they go about the business of deploying capital.

We need to encourage long-termism in investing (at least five years but usually longer), creativity, real alignment of interests and, perhaps most important of all, the resolve to ignore the short-term profit demands of shareholders who are just share price speculators.

«This is a dysfunctional system that undermines the stewardship of capital»

Company management routinely declines to invest cashflow in potentially lucrative opportunities because they know their shareholders will just see lower current profits, not long-term value creation. This is a dysfunctional system that undermines the stewardship of capital and the enhancement of productivity.

So, what should we be focusing on?

Firstly – for investment managers who want to create wealth and do something socially useful - seek upside and have conviction. Concentrate on the opportunity and operational progress within companies. Have faith in the clear evidence that in the long term, companies that perform best operationally have the best-performing share prices. Few investors appreciate that almost all long-term net wealth creation in stock markets can be attributed to a tiny number of companies that grow exponentially, so don’t use up your resources examining every possible investment when most have no chance of such growth. As a starting point for constructing a portfolio, we should completely ignore market indices. They are backward-looking and reflect a market that routinely overvalues historic growth and underestimates change.

Secondly – work constructively with the management teams of exceptional companies. They are the allocators of capital in the real world. One of the most valuable things we can do on behalf of our clients is to encourage inspirational founders and leaders to stay focused on their long-term vision and ride the inevitable ups and downs with them.

Thirdly – align our own timeframes with the reality of fundamental capital deployment. Investment managers who are paid bonuses for annual performance, or for sales and assets under management, do not have the same goals that investors with a 10 or 20-year horizon do.

I could go on - there are so many areas for improvement.

«This is not about trying to outsmart each other trading shares»

Some institutional investors, particularly pension funds and insurance companies, have a difficult task of balancing shorter-term funding and solvency requirements with the realities of long-term investing. Ignoring share prices that swing wildly, driven by speculative investors, is easier said than done when you have a balance sheet or corporate sponsor to worry about.

But to serve society better the investment management industry surely must do its part in helping businesses create newer, better and cheaper ways of doing things, displacing the old. We need to create a system of patient capital that can generate outsize investment returns by solving outsize problems.

A system that does so in a sustainable way that doesn’t do irreparable damage to our environment or to society itself. This is not about trying to outsmart each other trading shares.

Stuart Dunbar joined Baillie Gifford in 2003 and is a Director in the Clients Department. He became a Partner in the firm in 2014 and is responsible for overseeing relationships with financial institutions, as well as contributing to consultant relationships, marketing and client servicing activities in Europe and Asia. Prior to joining Baillie Gifford, Stuart worked with Dresdner RCM in Hong Kong and Aberdeen Asset Management in the UK. He graduated BA in Finance and Business Law from the University of Strathclyde in 1993.

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