Weekly Digest

Making the Difficult Decisions

Michael Clough

15 April 2019

When we meet with fund managers we spend just as much time discussing holdings they have disposed of as those they have recently purchased. Why did they sell out of that position? Was that in line with expectations given our understanding of their process and philosophy? Why did it take them many months to sell out of a stock? These are some of the questions we think about and put to all our incumbent and potential new managers. Selling also plays a crucial part in our own investment process and we recommend clients challenge us on why we have sold holdings or indeed why we continue to hold managers when, say, they are materially underperforming.

Ensuring you have strong sell discipline is crucial within any portfolio. Of course, it can be a difficult decision. You spent weeks and months researching a strategy in depth to build conviction, all for something to change either abruptly, or more subtly over time, and action must be taken. Ultimately though, why hold on to strategies you no longer have confidence in? You must replace them with those you really believe can either add alpha to your portfolio or improve an existing blend within the portfolio.

Let’s explore some of the reasons why we replace managers. Starting with the more obvious, a key individual or the team leaving a firm would often result in an automatic sell, not only because they are responsible for the alpha generated but we also do not want to be the last out of a strategy, knowing a manager departure usually leads to an instant sell rating from consultants. Corporate change which we view as harmful or a clear change to the investment process would also be warnings. Poor performance can also clearly be a factor in a decision to sell and one of the hardest decisions can be selling a manager who has significantly underperformed.

There are less obvious changes though too. Style drift is something which can only really be identified by forensic portfolio holdings analysis. Is there sufficient evidence that the manager’s philosophy is changing? We analyse monthly holdings going back several years to answer this question. Poor capacity management, or crucially a lack of acknowledgement of its importance, is another major concern. Higher assets often means less flexibility and managers may not be able to access the opportunities they really want to, and/or it takes them far longer to implement their desired strategy as it takes longer to build and sell out of positions.

Having back up managers or a ‘subs bench’ in place can help the process. It allows you to have conviction in your decision rather than let the process drag on. Having detailed notes covering why you invested in a manager in the first place (and identifying in advance what might be reasons for selling in the future) is a great reference point when assessing if things have changed over time. Face the issues straight away. Some decisions are easier than others and can be made quickly. Others require more work, analysis and a formalised discussion but addressing issues immediately serves to make for a more efficient decision.

At Momentum, selling managers is never a decision we take lightly. Whilst the intention when first investing with a manager is clearly to be longer term holders, things do change, and we are not afraid to make the difficult decisions when required.

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