Freeman-Shor, The Art of Execution

The Art of Execution: How the World’s Best Investors Get It Wrong and Still Make Millions by Lee Freeman-Shor (Harriman House, 2015) is a slim book. Its goal is to sear into the reader’s brain one key message: that investments need to be managed. In the words of the old saw, investors need to cut [or double down on] their losses and let their winners run.

The author manages over $1 billion in high-alpha and multi-asset strategies for Old Mutual Global Investors. From this position he was able to analyze 1,866 investments, representing a total of 30,874 trades, made by 45 leading investors from June 2006 to October 2013. He had given each of these investors between $20 and $150 million to invest for his Best Ideas fund, “with strict instructions that they could only invest in ten stocks that represented their very best ideas to make money.” (p. 6) Only 49% of these investments were profitable, and yet most of the investors still made a lot of money for the fund. The key to their success was knowing what to do when they were losing and what to do when they were winning. In brief, the bulk of their success came from wisely managing their positions.

When these investors had losing positions, they adopted one of three personae: Rabbits, Assassins, or Hunters. The Rabbits, whom the author wishes he had never hired, exhibited a buy and hope mentality. They did not adapt to changing circumstances; they did nothing to mitigate a losing situation. Of the 946 investments that lost money, 19 lost more than 80% and 131 lost more than 40%. Of those that fell by 40%, not one eventually produced the required returns to get back to breakeven.

The Assassins had stop losses in place, so that all losing trades would be killed when they were down by 20-33%. They were right to take action. Of the 946 losing investments, 41% saw their share price decline further. Of the stocks that subsequently rallied, only 37% returned more than 20%. So, the author concludes, “two-thirds of the time you are likely to be better off cutting a losing position.” (p. 33)

The contrarian Hunters pursued a Martingale approach, doubling down either when they thought that a bottom was in place on a stock in which they still believed or when its stock price had fallen between 20% and 33%. They too posted positive returns even though the odds were against them.

Investors who have winning positions can either be Raiders or Connoisseurs. “Raiders occupy a thin line between success and disaster. These are investors who like nothing better than taking a profit as soon as practical.” (p. 52) They don’t let their winners run. Furthermore, the author notes, “Raiders are often Rabbits when they’re losing—and the combination is fatal.” (p. 58)

Connoisseurs are the most successful investors even though, in the author’s sample, only a third of their ideas made money. What sets them apart? They invest in companies with a predictable growth of earnings and yet look for significant upside potential. They invest big and have focused portfolios. Up to 50% of their assets might be invested in just two stocks. They take small profits along the way but keep the majority of their positions in play, riding their winners. And, of course, when their positions turn into losers, they become either Assassins or Hunters.

Freeman-Shor’s message isn’t new, but it’s one that’s always worth repeating.