For Professional Investment Fund Managers, “Going Long” is a Winning Strategy

Billionaire investor Warren Buffett is widely known for his long-term, growth-focused investments in firms with strong fundamentals. He famously stated that his “favorite holding period is forever.” Research from the Smith School’s Russ Wermers confirms that a long-horizon holding strategy produces good outcomes for those active investment fund managers with the skills to employ them, and investigates the reasons why. Wermers also finds that individual investors benefit from the higher net-of-fee returns of these funds.

Wermers’ research, published as the lead article in the Journal of Financial and Quantitative Analysis, introduces a unique and simple-to-measure, point-in-time fund “Holding Horizon (H-H).”  The H-H measure looks at how long, on average, stocks are held by a mutual fund manager, then relates this to the fund’s risk-adjusted performance (alpha). In doing so, the article is the first to provide empirical evidence that focuses on the long-term performance–up to five years–of actively managed equity mutual funds through an analysis of their portfolio holdings.

The research shows a wide range across managers in how long, on average, they hold stocks, and that the managers with skills that allow them to profitably hold stocks with superior long-term fundamentals for the long-haul have the best returns. These managers attract long-term individual investors who are patient with their active managers.

“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,” write the researchers.

Wermers, the Paul J. Cinquegrana ’63 Endowed Chair in Finance and director of Smith’s Center for Financial Policy, worked with Fabio Moneta of the University of Ottawa and Chunhua Lan of the University of New Brunswick.

“Our evidence indicates that these long-horizon funds use their insights about firms’ future long-term fundamentals to forecast stock prices,” the researchers write. 

Importantly, Wermers and his co-authors show that, despite being a simple statistic of trading activity, a fund’s turnover rate is misleading in determining that fund’s holding period, even though funds with high turnover generally have short investment horizons. The researchers’ new H-H measure treats all trades of a stock (until it is completely liquidated) as being part of a unified strategy; i.e., if a fund manager continues to believe that a stock has favorable fundamentals over time, she continues to build her position in it. As a result, when a manager increases a stock’s position due to an updated belief, a fund’s H-H measure becomes longer. In contrast, the manager may have an increased level of turnover due to building such positions–highlighting that turnover (or its inverse) is an imperfect measure of the manager’s investment skill.

“We show that stocks with large long-horizon fund ownership exhibit superior long-term fundamentals,” Wermers and his co-authors write. “Thus, the outperformance we document stems from long-horizon fund managers possessing valuable information about superior future firm long-term, cash flow-generating prospects.

The researchers say their H-H measure can help investors to better identify long- or short-horizon actively managed funds, and to invest accordingly.

Many people invest in mutual funds through their employer’s retirement savings plan. Most never — or very rarely — make changes to their investment selections. Wermers’ research shows that, if an investor in such a plan prefers actively managed funds, they can benefit from selecting long- rather than short-horizon funds,” then holding them for the long-run.

Read the research, “Holding Horizon: A New Measure of Active Investment Management,” published in the Journal of Financial and Quantitative Analysis, in June 2024.