RUN WINNERS, CUT LOSERS
I wrote a short review of “The Art of Execution; How the world’s best investors get it wrong and still make millions” by Lee Freeman-Shor back in 2016. It can be read below:
Its conclusions are as relevant today as they were then.
The evidence points to investment managers being no better than monkeys with a pin when it comes to picking stocks.
What separates the successful investment managers from the failures are their willingness to run or even add to winners, and to cut losses at an early stage.
Try and be an Assasin and not a Rabbit and, run your winners!
I’m sure what is true for professional investment mangers is equally true to private investors
Am I an Assassin or a Rabbit, a Raider or Connoisseur?
Written in July 2016
I have just finished one of the best investment books I have read in a long time; it contains some great little gems, which I hope will improve my returns. One never stops learning; I continually strive to become a better investor and what better way than by learning from the mistakes and insights of others.
“The Art of Execution; How the world’s best investors get it wrong and still make millions” by Lee Freeman-Shor, took no more than a couple of hours to read, can be found HERE and comes highly recommended.
The author appointed 45 investment managers to manage concentrated portfolios, valued from $20m to $150m, between 2006 and 2013. He instructed them to invest only in their best 10 ideas and he not surprisingly observed very divergent results. In this book he observes the differing methods of the managers; he found that in general, all the managers were much of a muchness when it came to picking stocks; of the 1866 investments made only 49% made money but what separated the winning portfolios from the also-rans, was execution. Some of the “legendary investors” were only right 30% of the time!
He found the managers fell into five categories. When it came to handling losing investments they were either assassins, hunters or rabbits and when dealing with winners, either raiders or connoisseurs.
An “Assassin” is an investor who deals promptly and unemotionally with his failures; cuts early, or at least at a pre-determined level and moves on.
A “Hunter” tends to watch, analyse and then at the right time add, in an attempt to average down and salvage the investment. Many were successful with this strategy; never perhaps regaining the whole loss but at least reducing it.
A Rabbit! Need I say more. They watched the investment continue to fall, neither cutting or adding. The rabbits tended to have the worst performance by far.
“Raiders” were managers who snatched at any profit they made; 10-30% was enough. The money was then re-invested and as we saw earlier, only with a 50%ish chance of success.
The “Connoisseur”, however, let the winners run, perhaps trimming now and then but at least having a decent exposure to the holding for the duration. These were the investors who made 100% or more from investments.
The best combination was the Assassin/Connoisseur and by far the worst was the rabbit/raiders; they invariably ended up being fired.
In conclusion, an excellent read and hopefully one that will sharpen the investment skills.
Lessons for me
An assassin or a rabbit?
Over the last four years, since I launched the JIC Portfolio in January 2012, I have considered myself more of an assassin than anything else. I have cut some holdings quite quickly, say after a 20% loss and in most cases, those stocks have continued to drop. Whether they dropped further or promptly rebounded is slightly irrelevant; the point is, I sought to minimise damage to the overall portfolio and move on.
In a few instances, I have acted as a hunter, adding to losing positions but I think my success rate here, has been no more than 50:50. In the last six months or so I have noticed a few rabbit-like tendencies creeping in; I currently hold three stocks of my 30, which are down 33%. The problem with a stock that is down 33% is that it has to gain 50% just to get back to break even! I will come up with a battle plan for those stocks and others in the Portfolio in the coming days. Going forward, I will endeavour to banish any rabbit-like leanings and keep my assassin’s rifle loaded.
I will also rethink my strategy around “Stop Loss Review Levels”; it is all very well reviewing but there is always a good reason to put off doing anything. Perhaps setting a firm stop loss would remove the emotion. I have always found that once done, selling out of a losing position leaves a wonderful feeling; you no longer spend an inordinate amount of time worrying about what to do with the holding but can move on and re-invest the capital, hopefully in a winner.
A raider or a connoisseur?
When it comes to the winners, I believe I have acted more like a connoisseur than a raider. I have always believed in running winners and if the position is not too large, adding. I have also been happy to give a position a haircut when it becomes overextended; not only does this lock in some profits but it enables me to pick up stock on any setback.
How many holdings?
The final point was on concentration in the Portfolio. The author found that the greatest success stories came from the fund managers’ best ideas, which begs the question, why not put more money into the best ideas, rather than dilute one’s efforts and returns, by adding more stocks? At the end of the day, the number of stocks one holds is a personal choice but one has to be careful that in attempting to build a diversified portfolio one is not involved in an exercise of” diworseification”; Warren Buffett puts it another way; “do put all your eggs in one basket but watch it very closely”. The number of holdings in the JIC Portfolio has been as low as 22 and as high as my self-imposed maximum of 30. I currently hold 28, with the top 10 positions making up 52% of the Portfolio. I think there is some scope to rationalise the Portfolio and bring the number of holdings down again, focusing more of the Portfolio on my winning positions.
If in a year’s time, if I have benefited from sharpening up my discipline around execution and it has had noticeable results, I will contact the author and buy him lunch!