Last week we featured a piece by James Anderson, a fund manager at Baillie Gifford, a more than a century old investment management firm, making it big in the world of new age tech investing, adapting its investing styles to the changing business models. Here’s a piece from another investment manager from Baillie Gifford, Lawrence Burns about yet another counter-intuitive aspect of investing – profit booking. Whether its high networth individuals or institutional investors, we are often grilled on this aspect of ‘sell discipline’. Yet the most common investing mistake as acknowledged by the most successful investors has been selling their winners too early. Burns says as much – “In fact, it is often not just wrong to take a profit, but it can be the worst possible mistake.”
He first cites the lopsided expected outcomes often seen in the long vs short debate: “equity investing is asymmetric — the upside of not selling is nearly unlimited, while the downside is naturally capped.”
He blames it on the investment managers’ performance measurement where only the loss of not selling early is captured (should the stock go down) but the opportunity loss of selling too early is never captured in performance management.
But most importantly, he cites research that shows that only a handful stocks deliver most of the wealth creation:
“Research by Hendrik Bessembinder, a professor at Arizona State University, has found that nearly 60 per cent of global stocks over the past 28 years did not outperform one-month treasury bills. That might seem a case for not investing in equities at all. But the reason equity investing as a whole is thankfully still worthwhile is due to a small number of superstar companies.
Bessembinder calculates that about 1 per cent of companies accounted for all of the global net wealth creation. The other 99 per cent of companies were a distraction to the task of making money. This should shake the very foundations of the investment industry.
The entire active management industry should be trying to identify these superstar companies since nothing else really matters. But, doing that requires a vastly different mentality to that displayed by the financial industry today. It requires focus on the possibility of extreme upside, not the crippling fear of capped downside.
Bessembinder’s research makes it clear that it is the long-term compounding of superstar companies’ share prices that matters. Investing requires patience to deal with the inevitable ups and downs that such companies experience as well as the ability to delay significant gratification.
Sadly, such behaviours are inconsistent with the incentives and annual bonuses of traditional finance. Nevertheless, they are prerequisites. After all, the point of superstar companies is that they can go up fivefold and then go up fivefold again.”
He then goes on to cite an extreme example of possibly the biggest opportunity loss of our times – Goldman Sachs selling out of Alibaba:
“In 1999, Goldman Sachs invested in Chinese ecommerce company Alibaba. Shirley Lin, who worked for its private equity fund, has said she was offered the chance to invest $5m for a 50 per cent stake. Unfortunately, she said her colleagues deemed $5m too risky and so they opted for investing a “safer” $3m.
Five years later their stake was worth $22m, a seven-fold return. At this point, the decision was taken to sell. In many ways this was a remarkably successful investment until, that is, you realise that today those shares would be notionally worth more than $200bn before dilutions are taken into account. That investment alone, if held, would have been worth nearly double the value of the whole of Goldman Sachs today.”
He first cites the lopsided expected outcomes often seen in the long vs short debate: “equity investing is asymmetric — the upside of not selling is nearly unlimited, while the downside is naturally capped.”
He blames it on the investment managers’ performance measurement where only the loss of not selling early is captured (should the stock go down) but the opportunity loss of selling too early is never captured in performance management.
But most importantly, he cites research that shows that only a handful stocks deliver most of the wealth creation:
“Research by Hendrik Bessembinder, a professor at Arizona State University, has found that nearly 60 per cent of global stocks over the past 28 years did not outperform one-month treasury bills. That might seem a case for not investing in equities at all. But the reason equity investing as a whole is thankfully still worthwhile is due to a small number of superstar companies.
Bessembinder calculates that about 1 per cent of companies accounted for all of the global net wealth creation. The other 99 per cent of companies were a distraction to the task of making money. This should shake the very foundations of the investment industry.
The entire active management industry should be trying to identify these superstar companies since nothing else really matters. But, doing that requires a vastly different mentality to that displayed by the financial industry today. It requires focus on the possibility of extreme upside, not the crippling fear of capped downside.
Bessembinder’s research makes it clear that it is the long-term compounding of superstar companies’ share prices that matters. Investing requires patience to deal with the inevitable ups and downs that such companies experience as well as the ability to delay significant gratification.
Sadly, such behaviours are inconsistent with the incentives and annual bonuses of traditional finance. Nevertheless, they are prerequisites. After all, the point of superstar companies is that they can go up fivefold and then go up fivefold again.”
He then goes on to cite an extreme example of possibly the biggest opportunity loss of our times – Goldman Sachs selling out of Alibaba:
“In 1999, Goldman Sachs invested in Chinese ecommerce company Alibaba. Shirley Lin, who worked for its private equity fund, has said she was offered the chance to invest $5m for a 50 per cent stake. Unfortunately, she said her colleagues deemed $5m too risky and so they opted for investing a “safer” $3m.
Five years later their stake was worth $22m, a seven-fold return. At this point, the decision was taken to sell. In many ways this was a remarkably successful investment until, that is, you realise that today those shares would be notionally worth more than $200bn before dilutions are taken into account. That investment alone, if held, would have been worth nearly double the value of the whole of Goldman Sachs today.”
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