Selling well is an art

Bad sales decisions lead to subpar investment results. Frank Thormann, portfolio manager at Schroders, points to four factors that explain why it is so much more difficult to sell than to buy.

“Benjamin Graham, the founder of value investing, was right when he said that the investor’s worst enemy is most likely himself. A wealth of research has since taught us how frequent and persistent biases can lead to poor financial decision-making. applies both for professional and private investors.

Active investors show e.g. continued poor results. They should shine amid the volatility of the coronavirus pandemic. But the opposite is true. Only one in four professional fund managers managed to beat the S&P 500 in 2021.

“Only one in four professional fund managers managed to beat the S&P 500 in 2021”

Research by Jin and Taffler (2016) shows that overall, buy decisions added 1.4% per year to outperformance, while sell decisions contributed -1.8% per year to underperformance. So most fund managers have a knack for selecting investment opportunities. But their poor sales decisions weigh heavily on results.

What explains the bad sales decisions? I think there are four psychological things to point out for this. To know:

Bias 1: Loss aversion
The natural fear of loss causes most fund managers to hold a losing position for much longer than is rationally justified. One possible remedy could be an institutionalized framework for automatic review of loss-making positions with explicit emphasis on future investment prospects.

A fund manager who refuses to sell an investment because of loss aversion may do so because he refuses to face the fact that a mistake has been made in the past. In an attempt to save face, we try to convince ourselves that by waiting, everything will get better. But rarely do mistakes resolve themselves while we look the other way.

Bias 2: Prefer easy solutions
The human brain has developed mechanisms to reduce a very complex world to easy decisions. In complex decision-making, we do not consider all alternatives equally, but quickly jump to the alternatives that come to mind first.

As a means of improving performance, investors should always ask themselves the same question, regardless of the reason for selling: Which stock in my portfolio has the worst risk/return over the coming period?

Bias 3: Depends on confirmation
A good dose of human optimism is valuable in many aspects of life, but not when it comes to rational decision making. Our innate tendency to think we are right clouds our thinking in important ways.

Once we have made an investment decision, we are committed to it. Unfortunately, this means that we have a strong tendency to interpret later data in a way that seems favorable to our original beliefs. This confirmation bias makes it very likely that we are missing important information that goes against our beliefs.

As a remedy, it may be useful to charge a neutral observer with the collection of negative data. Or create an analysis that explicitly focuses on what the data would look like if things went wrong.

Bias 4: Spend more time on buying than selling decisions
Countless hours are spent on procurement analysis, including writing long reports, extensive quantitative modeling and intensive team discussions. On the other hand, the decision to sell is often made much faster. As a process improvement, investors should spend a more meaningful portion of their time on selling decisions.

Once an investment has been sold, it is usually not tracked. It’s hard to learn about the success of a sales decision when you stop measuring returns. The solution is obvious: analyze the timing of every sales decision.”

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