Guest Blog from @AIMInvestTweets - Notes on the ‘Art of Execution’ by Lee Freeman-Shor

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My mate @AIMInvestTweets kindly offered up the following text regarding the ‘Art of Execution’ to give Readers a view of what is in the Book and to help with some ideas to consider. You may not agree with all the ideas laid out here, but it is extremely valuable to think about what is being said and how you tend to do things yourself and what if anything you could tweak in your own Approach to improve matters. No Approach should ever by set in stone and it is a case of slow adjustments and evolution over the years.

Huge thanks to him for sharing this with us and putting the effort in to make a nicely readable and thought-provoking Blog, and of course you can find a copy of the Book in Wheelie’s Bookshop somewhere.

Regards, WD.

‘The Art of Execution’ is a book that I have been wanting to read for a while because, whilst there are a plethora of books on stock-picking and the financial markets in general, there are relatively fewer books on investor psychology and what we should actually do once we have bought the stock. 

The story behind the book is quite simple. The author, Lee Freeman-Shor, gave 45 of the world’s top investors between $25m-$150m with the strict rule that they could only invest in their ten best ideas. He analysed all their trades and came up with this some interesting observations and collated them into this book.

General Observations:

• Only 49% of the ideas made money.
• Some of the legendary investors were only successful 30% of the time.
• Despite this, some of them made money. And this was all down to the Art of Execution.
• Investing is not the preserve of so-called experts.
• The key is money management.

Part 1 – I’m losing, what should I do?

• The author analysed all the trades and came up with 3 distinct groups (types of investor) when it comes to shares being down – The Rabbits, The Assassins, The Hunters.
• The Rabbits were the least successful, even though some of them were prestigious investors.
• Example trades of the Rabbits: Vyke Communications (bought at 210p, sold at 2p); Vostok Nafta (bought at 914 cents, sold at 395 cents); Raymarine (bought at 427p sold at 17p).

Group 1 - The Rabbits:

• Cognitive bias: constantly adjusting story to make the stock look attractive and not being objective.
• Falling in love with the share; not accepting new information; not selling quickly for fear of realising a loss too soon; going with the crowd; ego (don’t like being wrong); blaming external factors (the market is wrong, I was unlucky); seeking more information but then not doing anything with it (so they don’t buy more, nor do they sell, they just do nothing); too big to fail (they didn’t want to sell something that comprised 10% of their whole fund at a loss); I’m due a win (taking gambler mentality into shares and saying things like “it’s bound to bounce back from here“, “it can’t go lower“, etc).

What the Rabbits should have done

• Have a plan before you enter as to what you do if stock falls x%; sell or buy more – don’t just do nothing, you must materially adapt – ask yourself, “if I had a blank piece of paper and were looking to invest today, would I invest?”; make a decision around the -20% mark; don’t go all in, keep some money on the side – don’t be in a position where you can’t act because you have no more money; don’t be hasty to jump in, but rush to get out – it’s easier to get into something than out; be humble – the market can often be right even if you think otherwise. 

Group 2 – The Assassins

• These guys religiously and automatically sold at 20%-33% down. They were cold-hearted and emotionless about it.
• Assassins also killed stocks after a certain amount of time because time is money. Being in a losing position for too long can hurt you even if it’s not as bad as 20% or more down. Small losses kill you slowly.
• Frequently cutting at small losses doesn’t make you a bad investor; quite the opposite.

Group 3 – The Hunters

• These guys would average down. Case study: Experian (bought at 902p initially; sold at 706p. Ordinarily a 22% loss, but the Hunter averaged down at 566p and therefore realised a 19% profit overall.
• You must decide for yourself when to be an Assassin and when to be a Hunter. 

Part 2 – I’m winning, what should I do?

• Two types of investor here: the Raider and the Connoisseur.
• Raiders sold at quick profits e.g. 20% up.
• One of the Raiders had an incredible 70% success rate in his stock picks (i.e. 70% of his stocks went up in price) – but didn’t make any money due to his (small) profit taking.
• Analysing the data, 61% of the stocks Raiders sold early carried on going up.
• The key is to ride winners because you will usually only get a minority of your picks right, so they need to bring in the big money.
• The Connoisseurs, on the other hand, rode the winners. They would scale out of companies gradually so whilst they did partake in profit taking, they would not sell their entire positions. So they would be selling little batches as they rode the share up.
• Don’t set unambitious targets.
• Invest big and focussed. Connoisseurs built up big positions in stuff they were confident in. They could end up with 50% of their fund in just two stocks.
• Have a high boredom threshold. Sitting on winners is boring but lucrative.
• Investing only in your best ideas has strong academic support (see book).
• Over-diversification is problematic – it doesn’t reduce risk, it just transfers it. 

An interesting anecdote
The author was invited to dinner with the legendary Crispin Odey. Around the table were a load of legendary investors giving their opposing views. You would think investing is a zero-sum game, that one had to be right over the other. But because of the Art of Execution, they were all winners in their own ways.

Five winning habits

1. Invest in best ideas only – ‘why not buy more of your best idea rather than your 60th idea?’
2. Position size matters – invest a large amount in each of your best ideas, but not so much that one decision is fateful. Keep some money aside to average down and don’t go all in on day one. Don’t invest in too many ideas and over-diversify.
3. Be greedy when winning – stop trying to make a quick 20%.
4. Materially adapt when you are losing (see part 1).
5. Only invest in liquid stocks – nothing worse than not being able to get out.

Conclusion
I highly recommend this book for two main reasons:

• It will give confirmation that your strategy is correct, or convince you that your strategy is wrong; and
• Even if you end up arriving at some other strategy of your own, it will at the very least get you thinking about the Art of Execution and recognising its importance in your investing strategy. It goes back to the old adage of not losing money as the first and foremost consideration.

Given the nature of the book, I would probably only recommend this for people reasonably au fait with the whole investing scene (the type who reads this blog!). It is a very easy read in that it isn’t technical and you don’t need to sit there with a set of accounts, charts, a calculator, and the whole works. I read this is in one sitting at night and it certainly got the old grey matter working.

Many thanks for reading and please feel free to follow @AIMInvestTweets on Twitter.