Why Allocators Do Badly When Selling Stocks

Institutional investors buy equities much better than they sell them. That is due to a lack of care in the selling process—and results in lower returns on the divestments, according to Michael Ervolini, former CEO of Cabot Investment Technology, now a subsidiary of FactSet Research Systems Inc.

These investors could gain 100 basis points annually for their portfolios, in 85% of the cases studied by Cabot, if they were wiser about selling. The study by Cabot, which advises institutions, found that only 29% describe their selling procedure as highly disciplined, using research and backtesting to track how they did.

For investors, fixing loose selling practices is more important than ever because actively managed mutual and exchange-traded funds—which stand in as a proxy for the entire investing field—are dwindling in importance as passive continues to outperform active. This outperformance has gone on for 20 years, with the performance gap growing.

Making the problem even more acute now: Assets held by passive funds moved ahead of actives’ holdings in 2023, by $13.3 trillion versus $13.2 trillion, according to a Morningstar study. Hence, this returns-lag subject is top of mind lately among active managers.

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Ervolini, author of a book that explored the subject, “Managing Equity Portfolios,” notes that often investors hold onto a stock well past its peak, so by the time that they sell it, the asset fetches far less than it could have. FactSet bought Cabot in 2021, and until recently Ervolini served as a “distinguished fellow” at the company.

Psychologically, buying is more enticing than selling, states Ervolini, quoting Terrance Odean, an economist at the Haas School of Business, University of California, Berkeley. Odean told him: “Buys have no baggage. A manager picks a buy in terms of what it can deliver in future performance.”

By contrast, old stocks may disappoint. Investors “hold onto winners longer than they should,” Ervolini says. And sometimes they chuck out more recent purchases before it’s clear how they will do over time. “Selling too quickly or too late can cost the portfolio as much or more alpha than what is generated from buys,” he warns.

Often, failure to assess what went wrong and what went right with long-term holdings steers investors into a ditch full of regrets, in Ervolini’s estimation. Academic journals seldom cover selling, with buying receiving the bulk of consideration, he laments.

How should investors go about selling? First, look at the record to see what worked, Ervolini advises. Next, before an upcoming sale, he says, “slowing down and thinking twice” helps avoid a rash move. Afterward, he adds, get “timely feedback” from others.

Of course, allocators always are selling, whether they have strong active trading programs, or concentrate on following indexes—they still have to rebalance to synch up with index shifts.

Asset allocators tend to be passive investors, although their approaches vary. For passive, the exemplar is the largest U.S. pension program, California Public Employees Retirement System. Some 70% of CalPERS’s liquid securities are passively managed.

On the other hand, the Florida State Board of Administration has the opposite method for its asset management of liquid securities. College and university endowments are more likely to pursue active management than pension funds do.

Regardless of the type of institutional strategy, the lack of attention devoted to selling, Ervolini says, leaves “this important skill difficult to appropriately understand and improve.”