IR teams often wonder why a major investor has sold out of their company given the great potential they believe the story continues to offer. According to one study, it’s possible the investor simply wasn’t thinking too closely about the decision.
A review of institutional portfolios across 16 years finds that fund managers are noticeably better at making buy than sell decisions. Why is this? In short, the researchers suggest that investors spend more time thinking about new investments. Sell decisions are more cursory in nature and may be driven by the need to raise cash – for the next big idea.
The study, first released in 2019, was updated and republished last month. It is titled ‘Selling fast and buying slow,’ a reference to the book Thinking, Fast and Slow by Nobel-prize winner Daniel Kahneman. The book famously discussed how human brains have a system for making quick, intuitive decisions and another for slower, logical deliberations.
The authors of the study – Klakow Akepanidtaworn from the University of Chicago, Alex Imas from Carnegie Mellon University, Lawrence Schmidt from MIT Sloan School of Management and Rick Di Mascio, CEO and founder of data firm Inalytics – argue a similar duality applies to investor decisions.
To conduct the research, they used data from Inalytics to review daily changes across 783 institutional portfolios between 2000 and 2016. Previous studies had looked at decision-making bias among retail investors, but in this case the team wanted to focus on professionals.
They measured the quality of decision making by identifying portfolio changes and comparing them against randomly generated buying or selling activity. When it comes to adding positions to portfolios, investors outperformed the ‘pick a name out of the hat’ approach by 1.2 percent per year. Sell decisions, however, underperformed the random activity by 0.8 percent.
What explains the difference in performance between buys and sells? The researchers believe it is down to the different ways fund managers approach the decisions. Investors spend more time considering buy decisions and weighing up the different options available to them. In contrast, sell decisions follow a more ‘constrained’ process where key factors include past performance and the need to raise cash.
To test this idea, the researchers looked at whether better decisions are made when investors are forced to think more deeply about a company. They did this by comparing decisions made on earnings announcement days – which should focus the investors’ attention on the company in question – to decisions made on other days.
Sell decisions made on earnings dates strongly outperformed random selling activity, bucking the usual poor performance. Buy decisions, on the other hand, displayed no change across announcement and non-announcement days, supporting the idea that these moments were already well thought through.
‘In equity investing, the real thrill is finding winners, and that’s where the majority of the time and effort goes,’ Di Mascio tells IR Magazine. ‘You’ve gone through all this trouble and come up with a great name to add to the portfolio, but in order to do so, you’ve got to raise some cash to buy it.
‘But you don’t have the time, and maybe the inclination, to do fundamental research on all the names in the portfolio to decide which one is the best to sell. So consequently, you revert to heuristics. You chose one to sell because it has gone up or dropped a lot.’
Di Mascio says the findings can give IROs greater insight into why investors may be selling their stock. ‘The paper highlights that decisions to sell are often not well thought out or due to a particular insight into the company,’ he says. ‘It’s subject to all these behavioral factors.’