Breaking up is very hard to do
Research suggests that active fund managers are good stock pickers. The problems arise when they try to sell
Active fund managers come in for a lot of criticism (not least from us). Investors pay them to try to outperform the market. But research shows that most of the time they fail to do that. As a result, passive funds – which cost less and simply track the market, which means that on average, they beat active rivals – have taken off in popularity.
However, a new paper from the National Bureau of Economic Research finds that active managers are actually pretty good at one half of their jobs. In Selling Fast and Buying Slow, researchers Klakow Akepanidtaworn, Rick Di Mascio, Alex Imas and Lawrence Schmidt analysed a database of trades made by fund managers across 783 different portfolios, from 2000 to 2016. They found that the managers were good stock pickers. The stocks they bought beat both their benchmarks, and also a strategy of randomly buying the same stocks, by more than one percentage point a year. In other words, when they hit “buy”, the fund managers not only chose the right stocks, but they also got
their timing right.
The trouble arose when they sold.
“Selling decisions not only fail to beat a no-skill random selling strategy, they consistently underperform it,” say the researchers. And they do so to the extent that they completely offset the good buying decisions. Why the gap? It mostly seems to be down to the selling process being less rigorous than the buying decision. Managers “appear to focus primarily on finding the next great idea to add to their portfolio and view selling largely as a way to raise cash for purchases.” Indeed, when managers sold in reaction to new information (such as disappointing earnings), rather than to clear room in their portfolios, these decisions outperformed the wider market.
So what can you take from this as an individual investor? If you’re picking funds rather than stocks, the conclusion is quite clear. Either go passive, or find an active manager who doesn’t sell very often (one with low portfolio turnover). Nick Train, one of the best-known active managers in the UK, has famously low trading on his funds.
If you’re a stock picker, the first lesson is always to have cash in your portfolio, so you can act on a shiny new idea without having to sell a stock that you may otherwise have been happy to hold. Second, use your time wisely. The more money you have in any given position, the more of your attention it merits. Finally, approach any selling decision as you would any buying decision – do your research. If you’re a serious stock picker, then you should have a record of why you bought the share in the first place. Has that rationale changed? If not, then why sell now? By treating “sells” with the same rigour as “buys”, you could make a huge difference to your returns.