Turning Losers into Gains

Holding on to losers in hopes of a rebound sometimes works, but for this manager it tended to lower performance. Consistent with The Disposition Effect, this behavior has been extensively documented within professional equity management.

Cabot is working with a 6+ -billion dollar Large-Cap, Core Fund that has beaten its benchmark on average by 75 basis points, for the past five years. The fund is managed primarily from a fundamental perspective using quantitative indicators intermittently; turnover is 1.09 times per year for an average holding period of 11 months. This successful manager can further improve performance through refining one aspect of his sell discipline. The critical finding for this manager is that he persistently holds on to certain types of losers far too long. Rather than rebounding as hoped, these losers continue to under perform and drag down returns. The solution for this manager involves helping him better integrate a single quantitative factor into his sell discipline, to trigger earlier fundamental reassessment and selling.

Now implementing a Cabot behavioral shift, this manager is being prompted daily to consider selling any loser held for more than 15 months whose Earnings Quality Factor (EQF) has severely degraded. In this case the behavioral nudge being delivered to the manager reflects a position's unrealized gain/loss (loser), age (>15 months) and expected performance (quantitative score). By consistently acting on the daily recommendations supporting this shift, the manager can add approximately 185 bps in return and 187 bps in alpha annually. The benefits from this shift are highly predictive based on excellent statistical findings from the "Out-of-Sample Testing" (P-Value <0.5%)