The art of knowing when to sell
INVESTMENT guru, John Train, colourfully illustrates how a misguided retail investor can make poor investment choices if he fails to spot red flags indicating when to sell.
“Truly losing money is when an asset you own falls apart, that’s like your barn burning down: something bad really has happened to you. It is holding onto a stock in the face of deterioration of a company that can cost you a packet. I’m told that if you place a frog in a pan of cool water and warm it ever so slowly over a stove, Mr Frog never makes up his mind to jump out of the pan and so gets boiled.
“Usually a company or an investment decays little by little. You have ample time to get out, if you just start doing so. Don’t let yourself get slowly boiled!” quipped Train in his book entitled The Craft of Investing.
There is no magic formula for knowing when to sell, but several signs can alert you to do so.
Sign No 1: Performance benchmarking
One of the best indicators for a sell or buy signal is a fund’s performance. The optimal way to evaluate a unit trust fund’s performance is to compare it with its benchmark.
A benchmark measures the performance of equity unit trust funds and comes in various forms. The Kuala Lumpur Composite Index (CI) performance can be a good benchmark for evaluating a growth fund or large cap fund’s performance.
Your fund can also be measured against the performance of its peer group average to gauge its relative performance. This is particularly useful for measuring bond funds given the lack of appropriate bond benchmark in Malaysia.
A fund that over one, three or five years consistently under performs its benchmark or its peer group average may be a strong candidate for sale, according to the rule of thumb in the fund industry.
Most fund managers provide you with data on your fund’s performance vis-à-vis an appropriate benchmark. If you believe the benchmark does not reflect the funds you have purchased, choose a benchmark that is reasonably close to the fund you are evaluating.
Sign No 2: Manager changes
Whether or not to unload your investment when your fund manager leaves or is replaced is a question that all investors should consider carefully. Of course, this should not be the only reason for you to sell your investments.
However, manager turnover information may help you understand fund performance data. In fact, performance information is more useful when interpreted with manager turnover information, and vice-versa.
Such changes can explain a pattern of deteriorating performance, and may reinforce a cautious “sell” decision. But, be aware that if a fund manager with a strong track record is brought in, it may be a confidence booster, persuading you to hold onto a lacklustre fund.
You should assess the level of influence the fund manager has had on the fund’s performance. You can conclude that your fund manager was responsible for your fund’s poor performance if he has failed to beat the benchmark for the last one to five years. This is a strong signal to sell your fund.
If your fund had performed poorly for the past one to five years but the fund manager managed it for a brief period, he is not completely accountable for its dismal performance. This does not mean, however, you should continue to hold the fund, but it is worth considering as a deciding factor.
If your fund is then taken over by a new fund manager with a sound track record at another similar fund, you may choose to continue to hold. But if he has never managed a fund or has a poor record, you should sell.
Also, make a distinction between managers of different unit trust funds. Changes in index tracker fund managers are less important than changes at actively managed funds.
AmInvestment Services chief executive officer Cheah Chuan Lok said: “Retail investors should not be overly focused on volatile short-term ratings. Instead, an investor should evaluate a fund manager based on his long-term track record.
“When your fund’s rating changes, find out why so that you can make an informed decision on whether to sell, or hold. Financial advisors regularly produce reports on factors that drive a fund’s short- and long-term returns”.
Sign No 3: Fund and fund-family growth
Morningstar Inc, a leading information source for unit trust fund investors, has found that asset growth can be a major problem. It advises investors to pay the most attention to smaller-cap or growth funds, most susceptible to asset growth.
Some unit trust funds are better managed when their total assets under management (AUM) are within a manageable size. A fund manager’s performance may suffer as their assets grow. Conversely, a rapid loss of assets can account for poor performance.
For example, ABC Technology Fund is a “hot” fund that grew from RM50mil to RM500mil due to a positive swing in tech stock sentiments. Let’s assume the fund manager has 25 good investment ideas or a maximum of 20 stocks on his A list. When the fund had RM50mil in assets, the fund manager could take an average position of RM2mil in each stock on his A list.
Now that the fund has RM500mil to invest, the average position will need to grow to RM20mil. The manager will face several difficult choices.
The manager can invest RM20mil or take larger positions in several of his best choices. This may lead to the fund owning a large percentage of the small companies it buys into.
This is undesirable for liquidity reasons and there are legal restrictions on how concentrated a mutual fund may become. The fund manager can expand his stock list beyond 25, by considering less attractive investment opportunities and move to his B list, also an undesirable decision.
A top performing fund may de- cline as the range of funds expands. When a unit trust management company adds new funds to the mix, fund managers may start losing focus on running investors’ funds.
Once you notice a significant change in the number of investment funds, ask how the management of your funds will differ when a new fund is launched, and if this means more work for your fund manager. If you are concerned about the asset size, find out if there are plans to close the fund.
Spotting red flags
You can glean insights into changes in your fund by visiting its web page to track growth plans and new fund launches. Monitor updates from independent sources about your funds. Managers may shift strategies when they smell trouble. A surge in assets may force your fund manager to change his strategy by investing in larger companies, holding more cash or trading less.
Shrinking assets are another red flag. If the firm’s assets erode, the company may retrench staff. Be cautious of fund managers who constantly fine-tune their strategies. To beat the market, you need a fund that can stand by its strategy, even when it bucks the trend.
Reasons to sell and not to sell
It is harder to determine when to sell than when to buy. Here are six good reasons for making that leap.
First, when there is a need to rebalance your portfolio to revert it to its original state. Second, sell investments when fundamentals have changed.
“When you bought shares in a company, it was growing. But when its growth begins to taper off and earnings growth is less than economic growth, it’s time to sell,” said Cheah.
Third, you may have misunderstood the fundamentals. For instance, if you buy a shirt that is too large, you may need to return it. Similarly, investments that don’t suit you need to be sold. Fourth, the fund may not live up to your expectations and fifth, your investment goals may have changed.
The sixth reason may be that you cannot take it anymore. Meeting your investment goals isn’t worth it if you develop ulcers or insomnia!
The next time you are thinking of “throwing in the towel” on your investments, cross-check with the sell signals highlighted in this article or review with investment advisors from reputable organisations. Don't let your emotions take your retirement plans down the drain.
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