The Art of Execution – What to do when you’re losing

The Art of Execution – What to do when you’re losing

This will be the first half of a review of The Art of Execution by Lee Freeman-Shor.

The book deserves five stars for its title, which is one the best book titles going:

The Art of Execution: How the world’s best investors get it wrong and still make millions in the markets

What follows might not seem like a particularly kind review. It’s probably my own fault for allowing my expectations to be raised to levels where disappointment was inevitable.

Part 1 of the book (there are two parts) is called I’m losing – what should I do?

The basic idea

The idea is that investors can be categorised into three categories, in accordance with what they do when they’re losing:

  • those who do nothing (Rabbits)
  • those who sell automatically with stop-losses (Assassins, who I would classify as medium-term traders)
  • those who buy more if they don’t sell (Hunters)

The name of the book was, I suppose, a hint that there would not be any fundamental analysis. There is no discussion in Part 1 of the book in terms of what makes a good or bad business, or a good or bad investment. So far, there is only discussion of share prices and what to do when they move against you.

This is an important question for new investors. For more experienced investors, I would say that the outline of the answer is obvious enough: you either sell automatically (if you’re oriented towards trading) or else you reconsider your investment thesis (if you’re an investor).

Doing nothing at all when an investment underperforms is going to be a bad idea – that is clear enough. People who do that are the Rabbits.

Lee Freeman-Shor advocates that instead of holding on, Rabbits should “Sell or Buy More”. This is where I have to dissent:

The only solution to a losing situation is to sell out or significantly increase your stake.

I would be one of the many investors and fund managers who would refuse to implement this idea. Instead, I would argue that holding on to a losing position is a perfectly reasonable thing to do, so long as I’ve done my maintenance due diligence and believe that the expected return is satisfactory from the current level.

It’s important to highlight that the timeframe which underpins this perspective is open-ended. I am not looking to exit a position in a year or two. If my timeframe is 12-24 months, then selling might be a good idea – because negative momentum tends to persist over that kind of timeframe. So I do agree that selling or buying more could make sense for some market participants, but it’s not something that would work for me.

I’m not a trader, and don’t use stop-losses, so I would never use the “Assassin” strategy which the author portrays favourably. Furthermore, it strikes me as dangerous to mix up this sort of strategy (George Soros is portrayed as a successful example) with something that a typical investor could hope to emulate.

And while Freeman-Shor deserves credit for collecting his own data to back up his points, their presentation robs them of their meaning for me. For example:

Of 131 investments that fell by more than 40%, only 21 went on to produce returns of over 100%.

The timeframe isn’t given. Does that mean they never doubled, even after 5-10 years?

Here’s another example from the chapter on “Hunters” (who buy on weakness), discussing Experian (EXPN):

Despite holding out through the credit crunch, this Hunter subsequently sold his entire stake five years later on 1 September 2011 with the shares trading at £7.06 per share… he realised a profit of 19% and not a loss of 22%.

It’s a good point that managing a position by buying heavily through a sell-off can add value. But making a capital gain of 19% over 5 years annualises to 3.5% per annum, which sounds less impressive. None of the returns given are annualised, and none of them are shown relative to a benchmark or target return.

As I said at the top, the real problem is that I may have expected too much from a book designed for a popular audience. Personally, I can’t study investment performance without thinking of the context: time horizon, objectives and benchmark performance. But these topics have all been left out of the analysis, so far.

The review of Part 2 will follow shortly.

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