Buy and Hold, But Know When To SellBuyandHold,ButKnowWhenToSell

No Sell Discipline? It Could Be Costly

Most global growth investors love to discuss what and how they buy, but that’s only half the job. As high-conviction active fundamental equity investors, Jennison Associates believes that selling is just as important as buying and can have just as large an impact on portfolio returns.

Too often, investors hold on to winners for too long, letting familiarity or complacency cloud their judgment as growth dynamics change. In our view, avoiding this pitfall is crucial to delivering attractive long-term risk-adjusted returns. In this article, we will examine the importance of sell discipline, factors to consider in sell decisions, and how short-term rigor enhances long-term focus.

Buy And Hold, But Prepare To Pivot

Evaluating a company’s fundamental prospects, especially for emerging growers, requires a deep understanding of its competitive advantages and growth potential that is developed over a long time. However, this long-term mindset should not be misconstrued as complacency or a plan to buy and hold forever. Because growth drivers are continuously evolving, the best global growth equity portfolios must continually reflect this evolution.

Jennison’s sector-expert analysts conduct deep research for each portfolio holding—including rigorous evaluation of financial statements and onsite meetings with senior leadership, customers, suppliers, and competitors—to develop fundamental outlooks and earnings models. The team focuses on the magnitude and duration of long-term growth drivers and is willing to accept short-term stock price volatility in exchange for potentially significant long-term returns.

Effectively identifying in advance the companies that will deliver high and sustainable growth is extremely difficult because most fail to live up to consensus growth expectations. To demonstrate this point, we grouped the MSCI All Country World Index into quintiles using historical five-year earnings growth, with companies in quintile 1 having the highest growth and companies in quintile 5 the lowest. After comparing consensus earnings estimates of companies in both quintiles to their realised earnings growth five years later, we deemed those that remained in the quintiles after five years as “hits” and those that dropped out as “misses.” In both quintiles, fewer than 20% were hits.

The market’s difficulty identifying long-term growth winners falls into two categories: ‘Overly Optimistic’ and ‘Overly Pessimistic.’ We believe in weeding out over-optimism stocks while allocating more capital to over-pessimism stocks as they may turn into long-term winners. For this reason, Jennison’s global equity team does not follow a strict “buy-and-hold” approach to investing. Holdings must earn their place in our global portfolio every day.

Patience Pays Off With Potential ‘Flowers’

Many growth darlings (e.g., Blackberry and Yahoo) that dominated industries for many years eventually lost leadership because of new technologies, new competitors or a new macroeconomic environment. So it would be complacent for us to assume that our current holdings will represent our best global growth ideas three or five years from now.

We prefer to be open minded and rigorous in our global portfolio construction, which means constantly identifying and exiting stocks where growth may be maturing, new competition may be emerging or execution may be declining. This approach allows us to be patient with potential ‘flowers’—companies we believe will blossom and potentially generate high returns and high growth over the long term.

The most successful companies over the long term have been able to innovate, evolve, and reinvent themselves. For example, Mercado Libre, Latin America’s largest online marketplace, continued to innovate by creating an ecosystem of additional product offerings around its e-commerce platform, including payment solutions, logistics, financing, advertising and software services.

Sell Discipline: Both An Art And Science

In Jennison’s global portfolios, we sell positions primarily for three reasons: 1) to fund more attractive growth opportunities, 2) to realise gains or 3) to reflect a change in fundamentals that alters our investment thesis. We are not satisfied holding a company—even if successful—if we believe there are more attractive opportunities available relative to the risk/reward in stocks we own.

We often sell a holding when the idea fueling its growth runs its course, the ‘new’ market gets saturated or the company appears to have no promising ideas in development. Even when a stock continues fulfilling our thesis, we sometimes sell when it reaches our price target.

Another reason to sell is a deterioration in the company’s fundamentals, such as a shortfall in earnings and revenue. Many earnings disappointments do not reflect a company’s longer-term potential, and investors will need to ride out these speed bumps. Other times, however, revenue and market share growth falls below our expectations for significant reasons, revealing flaws in our investment thesis. We rely on deep fundamental analysis to distinguish between the different types of disappointments.

In our Global Equity Opportunities representative portfolio, more than 50% of the stocks we sold underperformed the global portfolio in the subsequent one-year period following the sale. Over the subsequent five-year period, that underperforming percentage increased to 75%.

Short-Term Rigor Enhances Long-Term Focus

Great growth ideas can deliver strong returns for a long time, so it is crucially important that a sell discipline accounts for the risks of selling too early as much as holding a stock after its key growth drivers have matured. Our experience shows the need to focus on both risks equally, as a significant portion of our long-term returns have come from stocks we held longer than four years.

Earning A Place in Jennison’s Global Growth Portfolio

Many business models and ideas today are lumped together under the ‘growth category,’ but they may not offer exposure to pure growth. Understanding the differences one business model at a time—one growth driver at a time—can reveal enormous disparities. Some models become more cyclical as they grow and mature. Others accelerate as adoption rates and the size of addressable markets increase simultaneously. Investors need to understand this evolution in real time, determine the market value, and make a judgment on whether to buy more, hold or sell a security.

The sell discipline is one of the most complex and least-understood parts of the investment process. We believe it is essential to keep ‘weeding the garden’ by constantly monitoring the viability and investment thesis of each holding. Long-term growth companies are rare, and many fail to fulfill investor expectations. Each holding must continuously justify its place in Jennison’s global portfolios. Our sell discipline is a critical element in our investment success. It eliminates the companies that fail to fulfill our investment theses and offers us the capital to devote more resources to the “flowers” that we believe can potentially deliver long-term outperformance for clients invested in our global portfolios.