The academic research found “costly, systematic” bias in equity fund managers. “While investors display clear skill in buying, their selling decisions underperform substantially – even relative to strategies involving no skill such as randomly selling existing positions,” says the paper, Selling Fast and Buying Slow, which crunched data on 783 portfolios with an average $573m assets under management.
Buy decisions dominate sell decisions when it comes to fund manager attention, argued the authors from the Booth School of Business, University of Chicago, Carnegie Mellon University and Sloan School of Management, Massachusetts Institute of Technology, plus UK portfolio analysis business Inalytics. Using data based on 4.4 million trades between 2000 and 2016, the researchers created a counterfactual “no-skill” alternative to the trade whereby a stock picked at random was sold.
While stock picks outperformed the benchmark and a counterfactual random buy strategy, stock selling decisions consistently underperformed a randomly generated sell decision, forgoing between 50 and 100 basis points over a one-year horizon.
Architas investment manager Nathan Sweeney says he’s not surprised given the general characteristics of equity managers.
Sweeney says: “The type of individual in that role tends to have a high level of self belief, which probably leads to the ability to pick investments but probably also leads to the inability to be assertive when things are going a little bit wrong. There’s a big element of confirmation bias, because you’re trying to find research that suggests the reasons for investing in the first place remains in place.”
Some managers may be better placed to navigate this behavioural bias, says Sweeney.
“A long/short manager is more used to assessing why you shouldn’t hold a company as opposed to why you should hold a company.”
He highlights Stephen Moore, who manages the Artemis US Extended Alpha and US Absolute Returns funds, as an example of a long/short manager with a strong sell discipline. “At the moment you have a lot of people who are very constructive about the US market and he’s going in the opposite direction. He’s concerned about the level of debt in the economy, he’s concerned about quantitative tightening,” he says.
Contrarian investors going against the crowd also may have more disciplined sell strategies, he adds, pointing to Ardevora manager Jeremy Lang as an example and highlighting his thoughtfulness on behavioural biases in the investment process.
Exit strategies are particularly important for areas of the market that can be vulnerable to style drift, says Rathbones head of collectives Alex Moore.
“For example, when does a small-cap fund sell a stock if it becomes a large-cap? Does the fund have flexibility to run its winners or is it forced to sell as soon as it becomes ineligible?,” says Moore.
When it comes to fund houses as a whole, Sweeney highlights JP Morgan Asset Management for its strong valuation discipline.
Willis Owen head of person investing Adrian Lowcock points to Marlborough UK Micro Cap Growth manager Giles Hargreave as a small-cap manager with a strong discipline, stating he is active in managing the portfolio to stay atop positions and doesn’t take too much risk.
Sell discipline is particularly important with value and smaller companies funds, Lowcock says.
Man GLG Undervalued Assets was a fund highlighted for its disciplined sell process by several fund investors Portfolio Adviser spoke with and Lowcock also highlighted Schroder Recovery for the price targets it sets for holdings. Schroder Recovery starts selling a stock when it reaches a price level that reflects the team’s assessment of its intrinsic value, or if a material change in a company’s circumstances makes the assumptions made when it was purchased no longer valid.
‘No room for sentimentality’
Marlborough Special Situations fund manager Giles Hargreave points to Sophos as a stock sold from the portfolio throughout 2018 with the last share sold in October.
“There’s no room for sentimentality,” says Hargreave, who adds that he and co-manager Eustace Santa Barbara are generally happy to cut stocks losing money “without hesitation”. “Of course, it can be tempting to hang on and wait for the share price to recover, and sometimes that does happen. Often though, there’s a good reason for the fall and there’s further to go,” he says.
Sophos went from around £2 to over £6 in the course of two years and Marlborough didn’t feel confident management would be able to justify that share price, he says. Between March and July 2017, the team sold UDG Healthcare at an average price of £7.89 because it had “enjoyed a great run and we thought the valuation was looking stretched”. This month, they have readded to the stock at a price of £5.90.
Man GLG Undervalued Assets and Man GLG UK Income manager Henry Dixon points to JD Sports, ITV and DS Smith as examples of stocks sold in 2018. “Our sell discipline is threefold; when a price target is met, and with capital preservation in mind we look to shield ourselves from earnings downgrades and deteriorating balance sheets.”
JD Sports was sold in Q3 when it hit its price target due to a US acquisition, although price weakness the following quarter presented an opportunity for the team to revisit the stock, Dixon told Portfolio Adviser. DS Smith was sold during the same period due to a reappraisal of its balance sheet.
On earnings downgrades, the team sold ITV in H1 due to poor advertising trends as well as some investments. “While ostensibly cheap we note that earnings growth is usually required in order for the value to be realised,” he says.
DFMs highlight red flags
Some fund managers can have vague sell strategies, notes Rathbones’ Moore. “Justifications to hold or sell such as ‘investment thesis plays out’ or ‘the story changes’ are valid, but they are difficult to judge without getting trading data from the fund house. So if we were pursuing due diligence on a fund that lacks definition, that would be a big red flag,” he says.
Chase de Vere research manager Justine Fearns says they question managers on the life of a stock from purchase to sale, with a price target being hit or the original investment hypothesis no longer standing up to scrutiny often being triggers to sell.
“In relation to the paper, both these sell approaches could mean that a stock is sold as the price continues to rise meaning that investors miss out on further upside. However, a consistently applied sell approach that supports a fund’s investment objective means investors have a greater chance of understanding what they are investing into and what to expect from their investment in given market conditions.”
The number-crunching approach of the paper precludes qualitative factors, such as investment objective and mandate, which could contribute to when a stock is sold, she says, as highlighted by Rathbones in relation to style drift.
The approach of Lindsell Train UK Equity and Fundsmith Equity, which both seek to hold stocks for the long-term, would be difficult to argue with based on recent past performance, she adds.