Slow Finance

Almost everyone agrees that business as usual is no longer an option for capitalism. In his new book, Slow Finance, fund manager Gervaise Williams offers a vision of an alternative, based on longer-term, local investment. But can it deliver good returns?

by Jeremy Hazlehurst
Last Updated: 09 Oct 2013

In the early 20th century, the word 'fast' applied to card-sharping, cocktail-supping, debutante-seducing rakes and ne'er-do-wells. The City banker, at least in the popular imagination, is the modern incarnation of that; conning and conniving all day, then splurging his ill-gotten gains on champagne and girls at night. In its traditional sense, too, the word 'fast' applies to the City. Fund managers now hold stock for an average of seven months - in the 1960s it was seven years. High-frequency trading, in which stock is held for mere seconds, is increasing; over 60% of trading in the US stock market is now automated and about two-thirds of all equities trading globally.

Splicing and securitising everything, then selling it on to uncomprehending punters to make a fast buck is part of this culture. Speed is everything. Make your money, pocket your bonus and retire. That was the dream and still is for some. Short-termism rules. In the long-term, though, everybody pays. And everybody agrees that things have to change.

So if fast is the problem, is slow the answer? Recently, 400 pinstriped types gathered among the Old Masters and ersatz Egyptiana of the Mansion House to debate just how to put on the brakes. The main event was a lecture by Gervaise Williams, the managing director of fund management firm MAM and author of a book called Slow Finance (A & C Black). While many people are groping about for a way to change the City's culture, Williams has put together a detailed, well-argued blueprint for a better investment industry that concentrates on its core function of allocating funds efficiently, and where speculation knows its place.

Williams's argument is that the fund management business is riding the wave of a credit boom that has been going on since the 1980s and, thanks to quantitative easing, still is. Businesses can instantly find the money to fund expansion, raising their share price and giving capital gains to investors. This further encourages short-term investing as the industry chases quick profits rather than making long-term investments that create jobs. And so we get speculation in place of investment, and customers get volatility instead of value.

Intriguingly, Williams sees a connection between the finance and the food industries. 'The two share some fundamental characteristics - relationships are extending over longer distances, the growth in scale of the global, applied technology which makes it possible to develop and distribute products faster, and the inclination towards greater complexity within processed products,' he writes.

And junk food's alter ego is junk investment: credit default swaps are the hormone-pumped chicken nuggets of the financial world, and we don't know why those sausages are so suspiciously pink, any more than we understand what's in our pensions. Williams sees an alternative in the Slow Food movement, which promotes locally sourced, preferably organic, food. (Incidentally, it was started by a bolshie, Italian anarcho-syndicalist.) Slow Finance is Slow Food reinterpreted for the City.

The wider Slow movement is right behind Williams. Carl Honore, a well-known advocate of the Slow lifestyle, says: 'Turbo capitalism has become laser-focused so that people only deliver one graph, one figure. The Slow credo is about seeing the wider picture and realising that everything is connected. It's the idea that business is about more than jacking up the share price or maximising the bonuses, (and) seeing that investments have a social impact.' Slow Finance is probably the most thorough vision of a new model for business yet devised. It's framed as an investment philosophy, but clearly the larger aim is to remake capitalism. So could it work?

Williams' strategy has four strands. First, he advocates a version of value investing, the idea promoted by Benjamin Graham in his classic 1949 book, The Intelligent Investor. Investors should look for companies that are undervalued, on the grounds that over time they will appreciate and deliver a profit over the long term. Williams suggests relative value investing; buying stock in companies with a higher value of book assets relative to other similar companies.

The second principle is to look to make money from dividends and reinvest them in the business, rather than simply looking for capital gains. Dividend compounding means that your initial investment quickly increases. This would also mean that businesses have a reliable source of income and don't have to issue shares or go to the debt markets for capital to grow.

Third, invest locally. Williams is sceptical about investing in developing countries because growth doesn't always translate into stock market returns. China's GDP grew by 9.9% a year from 1985 to 2009, while the average stock market return was just 2.6%. Instead he advocates a local approach, mirroring the food business again with his concept of Investment Miles, the financial equivalent of Food Miles.

Local investments not only foster local jobs and communities, but also have the advantage that we can understand them better. 'You can drive past and see if the lights are still on at eight at night or whether they have gone home,' says Williams. 'You can find out from the bloke in the pub who works there what is going on.'

His fourth tenet is to invest in small businesses. Research shows that companies of 250 employees or fewer are the most productive, and therefore have the greatest scope for growth. It's just easier for a small company to double its profits than it is for Microsoft. Look at the RBS HG1000, an index that contains the smallest stocks on the FTSE All-Share. On average, between 1955 and now those firms grew at 17.3% a year. This is called, for obvious reasons, the 'small companies effect'.

Williams has some spectacular numbers to back it all up. A dollar invested in 1929 in the best small-cap value stocks would have become a mind-boggling $24,044,586 by 1997. A pound invested in the RBS HG1000 in 1955 would have returned £7,393 by 2010, compared with £620 in the FTSE All-Share. If you invested £1 in the DMC MicroCap index in 1955 you'd have £14,210 today.

Picking stocks for their ability to pay dividends relative to market cap is also a winning strategy. If you had invested £1 in the UK's top 100 such stocks in 1900, the cumulative return would have been £100,160. Those numbers can't be ignored. So is Slow Finance the alternative to the City's dysfunctionally fast culture?

If widely adopted, a Slow Finance philosophy should foster long-termism, promote local businesses and build communities. But the idea stands and falls on whether it would also make money. Pension funds and other investors would not give it a second glance if it could not provide solid returns.

And there's the rub. As Williams admits, a Slow strategy would have been very unsuccessful over the past 20 years, when the credit boom has favoured big businesses. Williams believes that once QE ends, we will go back to a situation that in important respects resembles the pre-credit boom era. If that happened, then Slow Finance would be a great strategy. But is that a reasonable assumption?

'Go predict the future,' says David Schwartz, a stock market historian and commentator. 'A lot of long-term investors were emboldened by the 1980s and 1990s (when a holding strategy worked), but it was the best 20-year run in several hundred years. People came to think that investing in the long run is the road to utopia.' Humility, he says, should be at the heart of any investment strategy. Part of that is admitting that - no matter how much data you have about the past - you can't know what the future holds. He doesn't invest for more than five years ahead.

That said, Schwartz is broadly positive about the Slow Finance principles. Looking for dividends is a solid policy, because the FTSE has not risen since the late 1990s and so a holding strategy would have delivered nothing. Nothing suggests that will change. He also agrees with investing in small-caps. 'The FTSE 100 is followed by some very smart people at investment banks, smarter than me, who are analysts that live and die, minute by minute following the big boys,' he says. 'Fewer people are looking at the small-caps, and they have less fire-power, so it's more of a level playing field and I have a better chance of making money.'

Greg Davies, a behavioural economist at Barclays Wealth, agrees that long-termism is a good investment strategy in principle, but 'the problem is that we live continually in the present. We impose on ourselves a time horizon, but in periods of crisis or turbulence it reduces to a month, a week, even a day.'

Long-term investing is sensible, but can be psychologically very uncomfortable. 'Some people hate to feel that they are locked into things and it can be right to give up some returns in order to feel secure.' A portfolio that keeps you awake at night is no good for you, even if you know that it will give you the best returns. Slow Finance might work only for people with a certain psychological make-up.

However, Davies is highly sceptical about some of the other Slow principles, especially investing locally. If the local economy nosedives, then your income and investments both tank at the same time. Geographical diversification reduces that problem. A preference for investing locally is an example of a 'familiarity bias', he says, a well-known but irrational tendency for people to invest in companies that they have heard of. This can buy you some emotional comfort - but at the expense of returns.

Davies also argues that investors actually don't know any more about local businesses than distant ones. 'By the time information reaches investors it is stone-cold,' he says, 'the illusion you know more than you do is dangerous.'

Slow Finance also advocates simple, comprehensible investments in companies with simple, comprehensible activities. Many people hold the impenetrable tangle of securitised debt products - the infamous CDSs, CDOs and CDOs of CDSs - responsible for the financial crisis. But complexity and innovation can be good. Interest-rate swaps work pretty well, as do catastrophe bonds. Exchange Traded Funds, in their vanilla incarnation at least, offer investors easy exposure to otherwise hard-to-reach markets.

When does complexity become too complex? No doubt some people found mortgages and insurance mind-boggling when they were first invented. Does everybody with a pension understand the Sharpe Ratio or Jensen's alpha measurements? Do they need to?

'Einstein said that you should make things as simple as possible without losing meaning,' says Edward Bonham Carter, the CEO of the massive fund management firm Jupiter. 'A car engine is simple, but also complex.' His point is that sometimes you need complicated things to perform simple tasks well.

It might be tempting to accuse Slow Finance of Luddism. But that's wrong. In his book Al Qaeda and What It Means to Be Modern, the philosopher John Gray argued that rather than being some medieval throwback, Islamism is as modern a phenomenon as the iPad, 'a by-product of globalisation'.

Although some of its features appear old-fashioned, Slow Finance is very modern and it is also a product of globalisation: just like Slow Food's farmers' markets. They sell organic food of the sort we supposedly used to eat, but the image of old-fashioned, artisanal purity is an illusion. The rich foodies who buy the food drive 4x4s and their wealth is a product of the globalised, exploitative, high-carbon economy. Like all that artisan-made, air-dried ham, Slow Finance can only ever be a luxury product for people who are willing to sacrifice some security for the satisfaction of investing locally and fostering small businesses. Slow Finance might be part of the solution, but only a part.

Honesty also matters. Andrew Harding of the Chartered Institute of Management Accountants, which advocates better financial reporting, says that one problem with the City is that the line between speculation and investment has become blurred. During the boom 'people thought they were investors, but they had become speculators'. The bankers told us that they had sewn our money into the mattress, when actually they had taken it down to the casino, cosied up to a voluptuous blonde and placed it all on red. There's no point having the best investment philosophy in the world if the person running it is crooked. Until crooks go to prison, that won't change.

There are what Carl Honore calls 'tensions' in all the arguments about reshaping capitalism. At the Mansion House talk, people said they wanted businesses that nurture local communities, but also a capitalism that enriches people in Africa and Asia. Fund managers admit to liking quarterly reporting because it allows them to keep tabs on their investments, but hate it when they have to do it because it encourages short-termism. Funds have too few stocks in their portfolios, making them volatile. But if we want active, long-term investors in real-economy businesses then those businesses' stocks will have less liquidity. It's not clear how to resolve these tensions.

Everybody wants more long-termism. The problem is that it comes at the expense of short-term gain. As investors, we might accept that if we believe our investments are socially useful, we might accept being poorer now for the security of long-term stability. Well, we might. But to do that, we'll somehow have to override the powerful human tendency to worry ourselves sick about tomorrow and next week rather than next year. We are naturally biased towards the fast approach rather than the slow: anyone who can change that is certainly going to be worth investing in.

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