Sometimes it's just a gut feeling

With a strong market capitalization and bright management team in place, the stock of Wridgways Australia Ltd., a trucking and courier company, looked quite attractive to Steven Rogé , co-portfolio manager of the Rogé Partners Fund. Therefore, on his gut feeling, he made the decision to buy it more than a year ago. Within a couple of months, the stock doubled in value. That meant it had met R.W. Rogé & Co.'s model of buying deep and selling at full value, so the firm sold it. Then the value doubled again. The sell decision was based on numbers, but Mr. Rogé 's intuition had a different message.
"I liked the company and knew it would grow," said Mr. Rogé , who serves as portfolio manager at R.W. Rogé , a Bohemia, N.Y., firm with $250 million in assets. "In hindsight, I should have recognized more of the qualitative side versus the quantitative side." Most financial advisers agree that behavioral finance plays a role in decisions. Buying and selling stocks is "very much an art and not a science," Mr. Rogé said. "There is no use for active management if human psychology didn't play into it." Observing the behavior in others can be beneficial, too. Anticipating other investors' reaction when a stock in his fund's portfolio was listed in a magazine's top 10 favorites led Mr. Rogé to sell his shares of International Assets Holding Corp. last year after it soared on popular enthusiasm but had reached its uppermost limits, in his opinion. "You could tell the amateur investors would pile on because of the chart and not the fundamentals of the company," he said. A recent survey conducted by Cabot Research of Boston found the majority of a group of 150 portfolio managers, executives, research directors and advisers at a CFA Institute conference said they were less analytical about selling than buying. In that survey, 70% of respondents said that decisions to sell are based largely on factors other than "highly disciplined, research-based and objective criteria." Of those, 65% said selling was based primarily on judgment, with analytics and opportunism also influencing sell decisions. Additionally, 39% of the portfolio managers said that they developed their selling discipline through "experience, and trial and error," said Michael Ervolini, the chief executive of Cabot Research. Meanwhile, 16% of managers said that they had a mechanism to evaluate the decision to sell. Twenty-three percent said that they used observation to see how stocks performed after they were sold, and 22% didn't track stocks after they were sold. A year ago, Cabot Research developed Cabot Behavioral Analysis, a software program that quantifies the impact of emotions on decisions to sell stocks. They applied it to eight funds representing $150 billion in assets. "We found in many cases persistent patterns that seem to be behaviorally motivated," Mr. Ervolini said. "In every fund, we found at least [1 percentage point] of opportunity to improve return." Common behaviors include changing investment strategy for fear of losing earnings, selling winners over losers and holding on to losers too long, he said. Some managers say they successfully keep emotions shut out of the process. "You'd better have your exit strategy in place before you have your purchase strategy," said Neil Hennessy, president and chief executive of Hennessy Advisors Inc. of Novato, Calif. He said that his firm has a quantitative buying and selling discipline. Emotions don't have to play a role in portfolio management, said Joseph Barrato, director of portfolio strategies for the Arrow DWA Balanced Fund (DWAFX) at Dorsey Wright & Associates in Olney, Md., who uses a quantitative measure called technical analysis. "We don't react to short-term changes," Mr. Barrato said. Every stock purchase and sale at the Ralph Parks Cyclical Equity Fund (RPCEX) of Rochester, N.Y., is measured against a system of technical investing, said manager Ralph Parks. He has also developed a way to measure confidence and fear in the market. "What I am doing is counting other people's emotions," he said. "We invest in the slope, not hope." But some say that ruling out emotion can't be done. "On the sell side, there is typically a history with the company which can make it harder to sell," said Barry Glassman, a financial planner with Cassaday and Co. Inc. of McLean, Va. "My sense is that judgment is the final arbitrator, but the research and due diligence supports their judgment." Not enough time is spent on exit strategies, said Scott Ford, president and founder of Cornerstone Advisors of Hagerstown, Md. "You have fear of regret on the sell side, which leads to holding losers for too long or selling losers too quickly," he said. Sue Asci can be reached at sasci@crain.com.