The Globe and Mail, Report on Business
Published August 23, 2008

For a while now I have been trying to buy my neighbour's property. He hasn't lived there for 15 years, but keeps it as an investment. When I broach the subject with him, he smiles and says, "Tom, we like to buy, we don't like to sell."

As investors in financial assets, we all wish we had that luxury, but we don't. Even for long-term "buy-and-hold" investors, selling is a key element of generating superior returns. And to make matters worse, the old adage tells us that "it is harder to sell than it is to buy."

Buying is simple. If you think a stock is worth more than it's trading at, you put your order in. Optimism rules the day.

When you're selling, however, there is a lot more emotional and psychological baggage, all of which clouds your assessment of a company's prospects and valuation. Irrelevant factors creep into the decision. Is it up or down? Is it controversial or loved by your clients? Is it a big part of the index?

Indeed, there is a whole stream of behavioural finance dedicated to this baggage we carry into a sell decision. For example, research done on loss aversion has shown that investors are less likely to sell a stock that is down from where they bought it.

One of the best sellers I ever worked with was Art Phillips, the founder of Phillips Hager & North Investment Management. He was a great investor because he didn't get married to things he owned. If he found something better, or the stock wasn't playing out as he'd expected, he would sell and move on. He had the mental strength and fortitude to ignore the burden of ownership.

For professional managers, selling is not only difficult to do, it is also difficult to articulate. When meeting with prospective clients, we are all required to have a page in the presentation on "sell disciplines." Even if the investor or consultant doesn't ask for it, which is rare, we want to show that we've thought about it.

Unfortunately, the commentary and slides are usually pretty lame (present company included). They are laden with platitudes and statements that are perfectly obvious.

"We sell when the stock reaches our price target or is fully valued." We all want that to happen.

"We sell if there is deterioration in the company's financial position, or earnings growth slows, or competitive conditions change." That's insightful, but none of those things happen in isolation.

Or, "we sell if our thesis for owning the stock has changed." This is the most concrete of the bunch, but is hard to act on. If a manager buys with the expectation that X will happen and then company management changes direction to focus on Y, there is a decision to make. The prime reason for owning the stock is no longer there, but it's hard to sell when the market is excited about the new direction. It all sounds pretty good.

Needless to say, selling is never as clean and simple as the marketing slides would suggest.

If a company's situation has changed for the worse, then it's likely that the stock has gone down and may be cheaper than ever.

There are times when a manager wants to sell, but doesn't have a hope of doing so because she/he has a huge position and liquidity has dried up. The market's response to the sell order? "You own it." In reality, large asset managers have to be opportunistic. If they're even thinking of selling, they have to be ready to move if a buyer shows up looking for a large block of stock.

Whether it is because of liquidity challenges or loss aversion, portfolios too often get littered with small holdings - once meaningful positions that didn't work out. These stocks weren't sold and now account for a tiny proportion of assets. It is rationalized that they are too cheap to sell, but no longer worthy of being added to.

I find that fund managers who own fewer stocks tend to be more decisive sellers. Some even have a rule that they can't own more than a certain number of securities. The manager of our equity fund, Cranston Gaskin O'Reilly and Vernon, restrict themselves to owning no more than 25 at any time. Among the many benefits of such a rule is the discipline it brings to the selling process. To stay in the portfolio, existing holdings have to offer a better reward/risk combination than a stock that is being considered for purchase. The manager is forced to toss off the baggage and focus on generating future returns.

I don't mean to make light of managers' abilities or what they tell their clients. Selling is hard, whether a stock has made you money or not. We all struggle with it. I know because it isn't one of my strengths.

And it has a special stigma attached to it. If you sell a stock that subsequently turns around, you are deemed to be undisciplined and too short-term-oriented. If you hang on and the turn doesn't come, you're just stubborn and not very smart.

The great buys get the glory. Great sells often go unnoticed or unappreciated.