“You gotta know when to hold ’em, know when to fold ’em . . . .” Kenny Rogers’s timeless advice applies to investing in a big way. An often overlooked piece of due diligence in choosing a money manager is understanding his or her “sell discipline” and whether it fits with your approach to investing.

So what is a sell discipline? “A good sell discipline is a set of criteria that you apply consistently to all the stocks in your portfolio,” says Justin Kelly of Winslow Capital Management in Minneapolis. “A sell discipline is meant to remove the emotional attachment managers sometimes develop with stocks, and to make the decision to sell more of a mechanical process.” 



When does Winslow cut and run?

With Clark Winslow and Bart Wear, Kelly manages more than $900 million in large-cap growth stocks, mostly for pension and endowment funds and other institutional investors. Over the past seven years, the firm has soundly outperformed the broad market indexes against which it measures itself. A key to that, Kelly says, “is not giving back your gains.” Conditions they watch out for:

›››  The fundamentals of the business are deteriorating. “We spend 90 percent of our time trying to anticipate change,” Kelly says. When change sneaks up on them and makes headlines, the firm’s managers adhere to a one-strike-and-you’re-out policy. “We do not buy bad news,” Kelly says. “We don’t double down on stocks. The better growth companies, when they first acknowledge a problem, usually have three more shoes to drop.”

›››  The valuation of the stock is “excessive.” An example, according to Winslow: Apollo Group, Inc. (Nasdaq: APOL), an Arizona-based education company. In the spring of 2004, momentum investors ran the stock to almost $100 a share—45 times projected earnings. There was no bad news on the horizon, just unrealistic growth expectations for a maturing company. Time to sell.

›››  A stock drops 20 percent from its high. “Sometimes the market may try to tell us something that we haven’t picked up in our research, so we do a full review,” Kelly says. “This may or may not lead to a partial sale of the position, but we often find incremental data points that could indicate a fundamental deterioration in the company’s outlook.”

›››  A position’s value reaches 5 percent of the portfolio total. Kelly says, “A higher weight in a stock often means you’re taking more risk than is prudent. If an outsized position drops in value, it’s very difficult to mitigate the effect that has on the entire portfolio.”



Likewise, Minneapolis Portfolio Management group watches for four conditions.

Phil and son Harrison Grodnick co-manage just over $400 million, mostly for wealthy individuals. The Grodnicks are contrarians—they buy stocks when conditions in a company’s industry couldn’t look much worse. Their sell discipline has helped them achieve a return on investment of more than 17 percent annually (net of fees) since the elder Grodnick founded the firm in 1995. Their red flags:

›››  The risks have changed. If a company’s financials deteriorate, its competitive position heads south, or the Grodnicks’ faith in management is shaken, they sell.

›››  The stock is fairly valued. Likewise, they sell if a stock has appreciated and there’s “distribution” in it, meaning investors are selling in greater volume on price downticks than they’re buying on upticks; the stock may not be going down, but the volume indicator is bearish.

›››  The stock is overvalued. Here, the price is too high in the Grodnicks’ estimation and they see waning accumulation; high-volume buying is trailing off, suggesting that investors have filled out their positions.

›››  We need cash. They also sell when a client needs to raise funds or execute a tax-related transaction.

The Grodnicks, unlike Winslow, allow their “winners” to exceed 5 percent of their portfolio—as long as the stock doesn’t fall into one of their other “sell buckets.”

Are these the only sell disciplines? Absolutely not. The point is that the managers are disciplined to sell when their emotions might tell them otherwise. Identify your investment manager’s sell discipline, and make sure it fits with your financial goals.