fixing mistakes: fast death vs. slow death

mistakes in general

One of the more important influences on my professional development was my immediate boss when I was running my first international portfolio.  I’ve written about her before.

–Her constant grillings on overnight Pacific stock prices pounded into my head the importance of observing daily price movements for the information they may contain.

–Her theory, or perhaps that of her British top-down mentor, that it takes three good stocks to offset the negative effects of a single clunker instilled in me how crucial it is to find and weed out mistakes as quickly as possible.

(An aside:  her idea was that a good stock could advance by 10% in a year, but that a bad stock would go down by a third before the average manager would smell the coffee.  I don’t think the numbers are necessarily accurate, but the sentiment is.)

Anyway,

fast death vs. slow death

Another of my boss’s favorite sayings–which has also become one of mine–is that “fast death is always preferable to slow death.”

What does it mean, you ask?

It has to do with fixing mistakes.

Suppose you have a large position in a mid-cap or small-cap stock  …one with low volume and/or a wide bid-asked spread.  You discover that business is not as good as you’d anticipated and the stock is likely to drop like a stone once more investors put two and two together.  What do you do?

Two choices:

–try to slowly trade your way out of the position, dribbling a little each day into the market (so that no one will notice you’re selling (as if you could keep this secret!).  That’s slow death.

–just shove the stock out the door, while others are still clueless.  Push the stock down 5%–10%, if need be–to unload most/all of it.  That’s fast death.  (This is the simplified version.  There’s technique involved in selling a large position, but that’s the general idea.)

Why is fast death preferable?

If the stock ends up 10% lower as your last shares get sold (and you’ve sold in equal amounts all the way down), your average price will be down 5%.  That’s not bad.

For one thing, you have the money to use to buy something else.

More important, if someone else discovers what you know and uses the fast death strategy, you’ll still have almost all your stock but the price will be 10% lower.  Even worse, the other guy will have used up a bunch of gullible buyers.  And his violent action will set alarm bells ringing that may cause any remaining potential buyers to change their minds.  Then you’re really in trouble.

People who choose slow death are delusional, in my view.  They don’t frame their situation using the fast death/slow death paradigm.  They want to pretend they haven’t made a mistake and that they therefore don’t need to act with any urgency in selling the bad stock.  In fact, they may think, maybe they don’t need to sell it at all.  They can consign it instead to the imaginary back room where bad stocks hide and can’t be seen (every portfolio has one).

why write about this?

It isn’t that we, as individual investors, encounter this every day.

What makes me think of this now is that bond investors are facing a similar situation in the overall bond market.  We know interest rates are starting to rise and that the upward movement has a very long way to go.  So losses are baked in the cake for anyone how continues to hold.  Why no fast death so far?