Fund manager ‘sell’ decisions costing portfolios dearly

New research by consultant Inalytics has found that, contrary to conventional wisdom, most fund managers cull their outperforming stocks and hold on to their underperforming stocks, often to the detriment of portfolio returns.

London-based Inalytics, which recently opened its Asia Pacific office in Melbourne, also found most fund managers are better buyers than sellers of stocks — and, again, their portfolios often pay the price.

It specialises in offering quantitative analysis tools to fund managers, super funds, and hedge fund managers to understand how alpha is generated for their portfolios.

The findings are contained in its research paper, Investment Timing — A critical part of the investment process, which finds that bad selling decisions can cause the loss of significant alpha.

Inalytics chief executive and founder Rick Di Mascio said this phenomenon is “best explained by the ‘disposition effect’ theory, which broadly explains that a tendency by investors to lose money when selling stocks does not occur by chance alone.

The research found that 57 per cent of stocks sold by fund managers had outperformed over the 12 months prior to the sale, according to Di Mascio, thereby “confirming the disposition effect that managers tend to sell winners”.

“We also investigated the shorter-term performance of stocks, and found that their average performance turns negative in the month before the sale.

“This finding suggests that this (negative) momentum is used as a proxy for research by fund managers and to oversimplify the process involved in making a sell decision.”

He added that the finding “confirms our belief that the typical fund manager feels more comfortable when looking for buying opportunities and this tendency has several (adverse portfolio performance) consequences.

“For example, our proprietary performance tool, Trading P&L reveals that purchases generate positive alpha to the tune of 154 basis points on average, but inopportune selling can cost 175 basis points.”