Stock-Pickers Know How to Buy, But Not Sell

Most money managers are better at buying than selling, according to an article by Bloomberg columnist Barry Ritholtz.

This is the conclusion of a report published in January that concludes: “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—in terms of both benchmark-adjusted and risk-adjusted returns.” According to Ritholtz, the paper’s most surprising conclusion is this: “Fund managers would be better off, and is some cases much better off, merely selling holdings completely at random.”

The report was based on a study of more than 89 million trading data points and 4.4 million trades associated with 783 portfolios, spanning the period between 2000 and 2016. The research looked at “2 million sells and 2.4 million buys made by veteran institutional portfolio managers.”

Ritholtz discusses the “asymmetry between buying and selling,” explaining that while purchase decisions look ahead and are therefore conducive to an analytical process, selling is a backward-looking event in which “the retrospective nature seems to be susceptible to the kinds of behavioral biases and cognitive errors we typically think of as common among non-professional investors.”

Asset managers, according to Ritholtz, don’t have an appropriate analytical framework for selling and instead use “crude rules of thumb or gut instinct, neither of which has a good record for yielding positive results.”

The report is interesting, Ritholtz argues, in how it evaluated performance. “Rather than comparing the portfolio returns to a benchmark, the study created what the authors call a counterfactual sell portfolio. Whenever the actual portfolio manager would sell a security, the counterfactual portfolio would sell a different, randomly selected security.” Ritholtz characterizes the result as “astonishing,” since the random sale consistently outperformed the one selected by the manager by a significant amount.

If active managers hope to regain market share, Ritholtz concludes, “they must become as skilled and disciplined at selling as they are at buying.” Given the results of this study,” he adds, “they have a lot of work to do.”