Lesson 6 of 7
Whose clock is running
A professional is judged on periods shorter than the time a thesis needs. That gap shapes what gets bought, and it is the one constraint an individual can drop.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Professional money is reviewed on periods of months, and a value thesis often needs years.
- That mismatch is not weakness of character. It is the structure Shleifer and Vishny describe, where clients withdraw on recent results.
- An individual can choose their own horizon, which is the most defensible advantage in this course and the easiest one to give away.
Two investors can hold identical views about a company and make opposite decisions, because they are answering to different clocks. The clock is not written in any model, and it decides more than most models do.
Three horizons over the same thesis
- QuarterThe report to clientsPerformance is compared with a benchmark and with peers. A position that has fallen has to be explained.
- YearThe reviewPoor relative returns lead to withdrawals, which shrink the fund whether or not the analysis was right.
- Three to five yearsThe thesisThe time a mispriced business typically needs for earnings, cash flow or a catalyst to make the case visible to everyone.
Where the pressure actually comes from
It is easy to describe this as short-termism and leave it there. The published mechanism is more specific and less moralistic.
Shleifer and Vishny's model has clients allocating money on the basis of recent performance, which means a manager whose position moves against them faces withdrawals at exactly the moment the position became more attractive. The fear of that outcome, the authors note, makes arbitrageurs more cautious when putting on the initial trade.
So the clock does not only shorten holding periods. It changes which positions are opened at all, in advance, by people who can see the opportunity clearly.
What the constraint rules out
The individual's version, and its price
An individual investing their own money has no client, no quarterly report, and no benchmark unless they choose one. That is a real structural difference and it is the reason patience is the most frequently cited advantage of the individual investor.
It is also the advantage most often surrendered. A person who checks prices daily, compares their account with an index every month, or sizes a position so large that a fall forces a sale has recreated the professional's clock without the professional's research budget.
What would have to be true for this to help you
Four conditions, all of them yours to meet
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The money is genuinely long-term. Capital you may need within the horizon of the thesis is not patient capital, whatever you call it.
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The reason for holding was written down before the fall, so that a decline can be checked against it rather than interpreted after the fact.
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There is no leverage, and no position large enough that a decline forces a sale.
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The clock you judge yourself on matches the clock the thesis needs, and you can say what would make you change your mind.
Fail any one of those and the advantage is theoretical. Meet all four and you have the one thing this course can honestly say an individual has that most professional capital does not.
Check yourself
What mechanism does the published model use for the pressure on professionals?
- Managers are impatient by temperament
- Clients allocate and withdraw money on the basis of recent performance
- Regulators require quarterly trading
Show the answer
Answer: B.
Shleifer and Vishny's argument is structural: money moves on recent results, so a position that widens against the manager triggers withdrawals.What does the clock change besides holding periods?
- Nothing else
- Which positions are opened at all, because the fear of being forced out makes the initial trade more cautious
- The tax treatment of gains
Show the answer
Answer: B.
The authors note the anticipation of forced liquidation makes arbitrageurs more cautious when putting on the initial trade, so some positions never happen.How does an individual most commonly give away the horizon advantage?
- By reading too many filings
- By using leverage, sizing positions too large, or judging themselves against an index every month
- By holding cash
Show the answer
Answer: B.
Each of those imports a forced-seller dynamic or a short measurement period into an account that did not have one.Sources
- Shleifer and Vishny, "The Limits of Arbitrage", Journal of Finance, 1997: performance-based arbitrage, clients allocating on recent performance, and the anticipation of forced liquidation making arbitrageurs more cautious in the initial trade.
- Baker, Bradley and Wurgler, "Benchmarks as Limits to Arbitrage", Financial Analysts Journal, 2011, for the benchmark-relative measurement this lesson describes.
What this leaves out
- Not all professional money is short-term. Some mandates are explicitly long-horizon, and family offices and permanent capital vehicles exist.
- A long horizon is not a strategy. Holding a failing business for ten years is patience applied to the wrong thing.
- Nothing here says an individual will do better than a professional, and the last lesson in this course states the disadvantages.
- None of it is advice about any security.