Rip It Up and Start Again

What if you started your investment portfolio again, from scratch?

Originally published in Citywire, January 2022:
Most things in investing, as in life, are the result of evolution. This means that, contrary to what the presentations imply, portfolios aren’t built and rebuilt from scratch each month.

Instead, they’re constantly tweaked: Maybe last month you switched in a couple of new holdings, or trimmed the allocation to equities. As such, most portfolios are works in progress; full of scribbles, crossing-outs, and wet ink — a constantly shifting mix of mistakes, triumphs and everything in between.

This poses risks. Is the sum of those carefully planted trees a forest that’s shaped in a dangerous way? Or have some parts become neglected, with your attention drawn to shinier opportunities or more dramatic problems instead?

January, the month of fresh starts, is a good time to ask yourself the question: Be you fund buyer or fund manager, if you were forced to sell your entire portfolio today, what would you put back in that pristine, empty space tomorrow?

This is a question I often ask fund managers, particularly when talking about a troublesome holding. It nearly always stops them dead. Suddenly they’re freed from their scribbly, work-in-progress portfolio, filled with emotional baggage as it is, and face instead the prospect of a fresh start.

This often presents them with a brutal truth: once you’ve been forced to sell a position, if you wouldn’t buy it back, then selling it was the right decision.

So sell it.

When you put it like that, investment decisions seem easy. This is why many good managers regularly run this thought exercise. I’ve heard of some doing it on a literal basis too: Everything sold on Monday, start again on Tuesday.

Emotional decision

Naturally, theory is different from practice. For one, there are dealing costs, so if you end up buying back what you just sold, you unnecessarily rack up a load of performance-damaging charges. For another, you may hold rare assets that, once sold, are gone forever (at least at that price). These are good reasons to keep this to thought-exercise and not real action.

But there are bad reasons too. As a fund of funds manager, I hated selling a fund, particularly if I was cutting it after a bad run, not retiring it with honours. Because, as much I know unemotionally ditching it is the right way to go, I’m no Mr Spock: the emotions are still there.

It’s emotive because no-one buys a fund expecting it to be a failure, so selling it means admitting exactly that.

But it’s also a by-product of the professional fund-buying process. Or it is for me, anyway. My edge comes from meeting, understanding and, ultimately, trusting active fund managers. This means building a relationship with them. So selling their fund means deliberately ending that relationship — an unpleasant undertaking in any aspect of life.

These emotional factors weigh on us as we run our ‘live’ portfolios. We may not admit it, but they’re pulling at the corners as we assess our winners and — particularly — our losers. But if all holdings have been systematically sold? With the uncomfortable business of admitting mistakes and cutting ties now behind us, the thought process becomes clearer.

For fund buyers there’s also a technical reason why 2022 is a good time to start again: fund charges have fallen. This means that, if you’ve held a fund for many years, there may be newer, cheaper share classes available, or that new investors are routinely being offered better discounts than you.

Fund houses, like car insurance companies, are (wrongly) reluctant to offer loyal holders as good a deal as they do new customers. The act of selling all your holdings neatly solves this problem because — hey presto! — you’re a new customer again. And even if they don’t budge, the act itself might force you to find a new, lower-cost fund that’s better than the (quite possibly bloated) fund you just sold.

I say all this from experience. I’ve had the chance to rethink things from scratch over the past year. And what I’m putting back onto my clean, new spreadsheet is different to what I left on the old one.

The Reshuffle

What’s on the new sheet, and what’s getting left behind?

I used to avoid global funds, as I wanted to control my regional weightings. It seemed like an obvious way to add value, but with a fresh perspective, I can see that it didn’t: if anything, it destroyed it. I can’t see much evidence that it adds value for anyone else either.

So now I’m happy to include a selection of active global managers and trust them to pick their best stocks, wherever they’re listed. These are often multinational companies that earn only a small minority of their revenue where they’re listed anyway (just one way in which allocating by region is becoming nonsensical), so I’m relaxed about letting regional weightings look after themselves from the bottom up.

As a result, I’m holding fewer regional funds, while adding global stock pickers to the roster instead.

But a portfolio made solely from global funds risks missing some of the good stuff in local markets’ hard-to-reach corners. So there’s still a place for genuinely active regional specialists — those prepared to look beneath the index’s headline-hogging large caps. These will, I expect, put me through a bumpier ride, but will end up providing the juciest returns.

Regardless, every fund I buy is a long-term position. If they’re as good as I think they are it’ll be years, if not decades, before I sell them. Or will it? Now I’ve tried it, the cleansing call of the emptied spreadsheet may be a hard habit to kick.

2023 Epilogue

I wrote this piece a year ago, as I was finalising the portfolios for a couple of funds I took on a few months later. The results have been good — one of my best periods relative to the peer group for a long time (possibly ever).

So much so that I’m now building the rip-it-up-and-start-again exercise into my investment process. What’s the best way of doing this? Literally? Metaphorically? Or something else — perhaps forcing myself, once a year, to sell the three holdings in which I have the least conviction? I’d be interested to hear your own thoughts and experiences on this.

But while I’m not sure exactly how yet, it will definitely feature — it’s proved too valuable an exercise for a one-off. Watch this space…