David Swensen held onto managers for decades. I recall several times when David stayed the course despite mounting evidence that a manager was unlikely to outperform going forward. I used to think it was the only systematic mistake that he made, but now I’m not so sure it was a mistake at all.
In a research paper published in July, academics from the University of Chicago, MIT, and Inalytics found that professional stock pickers add value with their purchases but underperform substantially with their sell decisions. Annie Duke sees the same trait in her work with money managers. Managers invest substantial time, effort, and process around buy decisions and next to none on their sell decisions. Her most recent research considers this problem, but we’ll have to wait a year for it to hit the bookshelves.
I find the challenge of handling losing positions particularly vexing. The emotional strain of losses compromises our ability to make sound decisions, and the biases towards loss aversion (hold) and window dressing (sell) call for opposite actions.
Private market strategies have the same negative bias on exits. Holding periods have compressed over time, despite the long-term lock ups afforded to managers. Even in venture capital, Sequoia’s recent announcement to restructure as a permanent capital fund noted that they had left tens of billions of dollars on the table by exiting too quickly. The term structure of traditional private capital vehicles compels forced selling for non-investment reasons, creating the same loss of value on optimal sell decisions as occurs in the public markets.
Swensen minimized errant sell decisions by systemically holding on through rough spots. In doing so, he lived with some managers that continued to struggle and others that had a reversal of fortune. I look back now and realize that I attributed the former to “mistakes” and the later to “patient, long-term investing.”
But you can’t have one without the other. People, organizations, and markets all respond and change, and investors cannot always get it right. Yale’s disciplined plan to stay the course at precarious moments for managers was a sound process through and through.
Holding on for longer reduces the number of sell decisions and offers one way to boost performance. Whether a stock, deal, or manager, reducing the number of at bats results in our swinging and missing less often.
The only other strategy I’ve found to mitigate poor sell decisions is to define an exit upon entry and stick to it. The best example of this is a one-off, opportunistic strategy. Last year, Dan Rasmussen created an opportunity fund to buy small cap value stocks in the thick of the pandemic. Verdad’s research defined the entry point and used history as a guide to determine when to exit. About a year later, Verdad made returned the capital to investors after windfall gains.
David’s investment insights compound over time. Holding on for longer or tactically knowing when to exit are the only methods I’ve found to mitigate poor sell decisions. Turns out the crypto phrase HODL (Hold on for Dear Life) isn’t such a bad strategy after all.