Interest rates tend to dominate discussions on monetary policy. Let’s change it up and talk about physical monetary policy, as in physical coins from the U.S. Mint.
Over the weekend, Caity Weaver of the NY Times published a fascinating (to me) article on the dilemma around pennies. If you haven’t seen it yet, I highly recommend a quick read!1
In short, the article very clearly explains why the penny shouldn’t continue to exist – most notably, each penny costs 3.07 cents to produce and distribute, resulting in a fiscal loss of over $90 million a year – and then covers in entertaining detail all the irrational reasons that the penny continues on.2
Among the highlights:
[W]e keep minting pennies because no one uses the pennies we mint… most [pennies] have suffered a mysterious fate sometimes described in government records, with a hint of supernaturality generally undesirable in bookkeeping, as “disappearance.”
[T]he question “Should we make pennies?” is, essentially, a personality quiz: Does the idea of losing money bother you enough that you feel compelled to stop it, even if the amount of money is trivial? Americans confront this question individually each time they receive pennies. Every penny deserted at checkout is a no. The government’s approach is the same as its citizens’. Sure, a person will eventually lose the price of a cup of coffee in left-behind pennies, and a nation will sacrifice enough money to install several hundred thousand reflective road signs that can be read at night. But if you can stomach the arrant waste, you are spared its contemplation.
I recall having a conversation with a Canadian friend around the time that Canada decided to end its production of pennies (Ms. Weaver touches upon that too in her article). Ten plus years later, the U.S. is still minting pennies. It’s hard to change the status quo!
Our question this week highlights the difficulty of moving on, whether it’s a penny or an investment.
How do I know when it’s time to change an investment?
This question comes up from time to time when I speak with other institutional investors, and perhaps unsurprisingly, I don’t think anybody has a perfect answer! None of us has a crystal ball (that I know of), so we must all make the best decisions we can with the information that we have.
I want to pause here and quickly make the distinction between evaluating a stock investment versus a fund investment. With a stock, investors might have price targets or models to reflect their estimates of intrinsic value. An investor might then view that price target as the impetus to sell. This type of analysis isn’t relevant when evaluating funds and investment managers (unless you’re referring to the publicly traded stock for an asset manager).
Evaluating funds requires a different type of investment framework and approach, with more resulting ambiguity. It’s why institutional investors often describe the learning process as an apprenticeship and why, for better or worse, there is an emphasis on pattern matching. It’s also why we care so much about team and incentive alignment.
That said, I strongly believe the best time to think about exiting an investment is at the very beginning, before you even make the investment.
As part of underwriting a fund investment, it’s important to consider the team, the strategy, and the opportunity set. It’s also valuable to think about how those factors might change. Think of it as a pre-mortem, an exercise in pre-identifying the ways that an investment might fail.
Now to keep yourself honest, write those things down somewhere. As you track your fund investment over time, compare what you see with your original underwriting, including your pre-mortem. Of course, you shouldn’t expect your pre-mortem to catch every risk, but as with anything else, your analysis will get better over time, and your considerations will grow more comprehensive.
In general, I think it’s important to distinguish between inputs and outputs. For instance, process is an input, though certainly not the only one. Performance is an output, and depending on the strategy, uncontrollable to varying degrees. Persistent poor performance is often a lagging indicator that something has gone wrong in one or more of the inputs – process, market opportunity, etc. Ideally, and it’s almost impossible to time perfectly, an investor notices changes in the inputs, prompting a re-evaluation of the fund investment.
Sometimes, the changes are subtle and happen over a prolonged period of time. And it can be easy to excuse each incremental change as not a dealbreaker. But viewed from beginning to end, the change can be dramatic. This is where it helps to keep a record of historical research and to track the magnitude of deviations over time.
As with many portfolio decisions, there’s no precise, definitive answer to when you should change an investment. Changing investments overly frequently can incur high transaction costs and missed opportunities (and likely reflects performance chasing, which is rarely a successful strategy). Being too slow to change investments can mean deteriorating performance and similarly missed opportunities.
In the end, if I find myself wrestling hard with a decision, one question is often the most clarifying – would I make this investment as a new investment today?
Hope everyone had a great holiday weekend, and as always, feel free to reach out: askacio@ivyinvest.co!
Until next week,
Wendy
Ms. Weaver makes reference to the minor role played by a private equity firm that some of us might know.