Buying stocks is easy – selling them is the difficult bit

Most fund managers don’t beat the market. Yet they are pretty good stock pickers. So what goes wrong?

934_MW_P14_Strategy

A better selling process for most managers

We know that most fund managers fail to beat their underlying benchmarks consistently over the long run, partly because their fees are too high. Any number of studies prove this point. However, this isn't necessarily because managers are bad stock pickers other papers note that managers' "best ideas" tend to beat the market.

So what's the problem? An interesting new study might have the answer. Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors, a 2018 paper from academics and researchers Klakow Akepanidtaworn, Rick Di Mascio, Alex Imas and Lawrence Schmidt, suggests asset managers are indeed generally good stock pickers. The authors looked at more than 750 portfolios between 2000 and 2016. On average, new buys beat both the market and a "counterfactual portfolio" where the researchers randomly added the money to an existing holding instead.

The problem arose when the managers decided to sell. Where a manager sold in a period around company news being released in other words, when there was a fundamental reason to sell their performance did not suffer. However, the same couldn't be said for other types of sale. Indeed, say the researchers, in most cases the average manager would have been better off by up to two percentage points a year by selling a stock completely at random.

So what's going on? The researchers conclude that it's all about attention or a lack of it. Managers do their research and consider all the angles when they are buying. But when it comes to selling, they take shortcuts (or use "heuristics", in the behavioural jargon). One reason for this is that the selling decision often comes about not because the fundamentals of the stock have deteriorated, but because the manager needs to raise money. And when a manager is trying to pick a share to sell on that basis, he or she tends to be drawn to those that have either lost a lot of money or gained a lot while sitting in their portfolio. In effect, when managers sell without thinking, they cut their winning stocks too early, or end up crystallising losses that they should have trimmed a lot earlier.

This has implications for your own selling process (in short, consider it as carefully as your buying process). But it also suggests a few tips if you are looking for a good fund manager. First, look for low portfolio turnover the less selling a manager does, the fewer mistakes he or she can make. Secondly, look for a relatively small number of holdings. If managers are good at buying, you want maximum exposure to their best ideas rather than a portfolio full of also-rans that are just there to make up the numbers.

Recommended

Rob Arnott: Covid's hidden investment opportunities
Investment strategy

Rob Arnott: Covid's hidden investment opportunities

Merryn talks to Rob Arnott of Research Affiliates about some of the unexpected consequences of Covid and their opportunities for investors, plus the "…
24 Sep 2021
University spin-outs: where to find companies involved in cutting-edge science
Share tips

University spin-outs: where to find companies involved in cutting-edge science

Universities are innovation incubators and often launch businesses involved in fast-growing fields ranging from biotechnology to artificial intelligen…
24 Sep 2021
Evergrande: Chinese property giant spooks global markets
China stockmarkets

Evergrande: Chinese property giant spooks global markets

Global markets fell this week as investors worried about the fate of Evergrande, China’s most indebted property developer, which is teetering on the b…
24 Sep 2021
Investing in football clubs: how you can profit from the beautiful game
Share tips

Investing in football clubs: how you can profit from the beautiful game

Football clubs may often be money pits for oligarchs, but they are also huge global brands, says John Chambers – and investors are now starting to rec…
24 Sep 2021

Most Popular

Should investors be worried about stagflation?
US Economy

Should investors be worried about stagflation?

The latest US employment data has raised the ugly spectre of “stagflation” – weak growth and high inflation. John Stepek looks at what’s going on and …
6 Sep 2021
Two shipping funds to buy for steady income
Investment trusts

Two shipping funds to buy for steady income

Returns from owning ships are volatile, but these two investment trusts are trying to make the sector less risky.
7 Sep 2021
The times may be changing, but don’t change how you invest
Small cap stocks

The times may be changing, but don’t change how you invest

We are living in strange times. But the basics of investing remain the same: buy fairly-priced stocks that can provide an income. And there are few be…
13 Sep 2021