By James Mackintosh
Warren Buffett doesn't sell his investments easily. His "favorite holding period is forever," he says. Jeff Bezos every year sends shareholders a copy of a 1998 letter to investors in a young Amazon.com Inc. declaring that he doesn't care about "short-term Wall Street reactions."
Yet neither Amazon nor Mr. Buffett's Berkshire Hathaway Inc. feature in stock-market indexes built to pick companies worth holding for the long term.
Their absence reveals a lot about the difficulties faced by those who want a simple way to invest for the long run.
There is no surefire way to detect a long-term attitude from the profit-and- loss account. Many of the companies that look far into the future are priced for growth far into the future too, making them expensive. And nonfinancial issues -- such as rankings based on environmental, social and governance concerns, or ESG -- are often used as a proxy for a long-termist approach. But they overlap imperfectly with other measures of long-termism.
A group of pension funds wanting a long-term approach backed the birth of the S&P Long-Term Value Creation Index three years ago with billions of dollars in part to encourage CEOs to look beyond the quarterly earnings cycle. Another index launched this year, the Matarin Global Long-Term Index, has a similar goal -- as well as making money, of course.
The trade-offs involved in constructing these indexes, neither of which includes Buffett or Bezos, are faced by anyone investing for the distant horizon. Should you care about the attitude of the CEO or the company's valuation? About the prospects for profits or the morality of the company's products? The return on equity or the environmental disclosures? None of the decisions is obvious.
Both indexes are global, but have little overlap in membership; only two of the Matarin top 10 holdings are held at all by S&P LTVC (CVS and Cisco Systems). In part, this is because of the different financial criteria used.
S&P LTVC screens companies for its measure of quality -- using return on equity, accruals (a way of gauging how reliably the accounts reflect true earnings) and leverage. Berkshire doesn't qualify, partially because return on equity doesn't properly capture the returns from its vast stock portfolio. Amazon is ranked as among the worst companies on these measures -- put in the bottom 100 of the S&P 500 for quality -- arguably because it has prioritized profits in the future, not profits today.
Matarin screens for cash flow and steady growth, knocking out Amazon because its growth, while extremely fast, has been so volatile. Berkshire makes it through this first test. Matarin then adds a value screen, which Amazon would also fail due to its high valuation. Its valuation is high, of course, because investors are excited about Amazon's long-term prospects.
Berkshire is kept out of the Matarin index because of its poor corporate governance scores: among other things, it has too few independent directors and a combined chairman and CEO.
Buffett fans would turn this on its head. What company is better-run than Berkshire, with its minimalist bureaucracy, stable leadership and excellent track record? Berkshire Vice Chairman Charlie Munger at the weekend dismissed the entire enterprise of scoring companies, saying: "The so-called best corporate practices -- I think the people who talk about them don't really know what the best practices are."
Long-term investors have an issue. Should they include Berkshire because it is obviously well run, or exclude it because they can't be sure it has the institutional safeguards in place to protect shareholder rights? Both indexes take a quantitative approach, but investors choosing for themselves would also have to decide about other companies that reject governance norms and don't have leaders with sterling track records.
Berkshire suffers from its dismissive attitude to the rest of ESG, too. Matarin insists on an improving ESG score, while Berkshire's lack of carbon and other disclosures hold it back. Berkshire, along with Netflix, is excluded from the S&P 500 ESG index for failing human-rights recommendations of the U.N. Global Compact, due to its lack of union recognition
Investors trying to assess long-term prospects often include ESG as a way to find companies less exposed to anticipated changes to the climate or society. Matarin goes further, excluding energy stocks, airlines, cruise lines and tobacco companies entirely, on the basis that they are not sustainable for the long run. This is at least debatable: a 2015 study found tobacco companies had produced the best returns of all U.S. sectors since 1900, a truly long-term investment, while fossil fuels will continue to be part of the energy mix for decades in all climate scenarios.
Again, what counts as long-term investing? Building a fossil-fuel power station or oil rig with an expected life of 30 years involves investing for the long run, but doesn't fit with climate goals. Building an electric car that relies on state subsidies to be profitable would tick the environment box, but might not be a sustainable business model.
There is also a clash between picking companies with a long-term outlook, and holding stocks for the long term. Both indexes try to fudge this with a rolling three-year holding period, even if a company no longer meets their conditions. But an investor tracking the S&P LTVC index since 2016 still switched stocks more than four times as often as those who just bought a passive fund holding the entire market.
That passive fund, of course, is what Mr. Buffett recommends for most investors most of the time.
Write to James Mackintosh at James.Mackintosh@wsj.com