Become a Smarter Seller, Part 1

"I can always find good stocks to buy, but figuring out when to sell is harder."

-- My mom

In some ways, my career in investing has been a happy accident. When I was at Provident Mutual, now a part of Nationwide Financial Services (NFS - commentary - Cramer's Take), I was the only financial analyst on a fund-manager selection committee, and I ended up interviewing 30 to 40 top money managers over a three-year period.

Our committee always asked candidates about their buy and sell disciplines, and the similarities and differences were interesting. Answers varied considerably on buy disciplines, but sell disciplines shared quite a few similarities, which fell into three categories. Most sold for one of these reasons:

The price target was met.

Momentum failed.

Fundamentals deteriorated.

A few of the better managers used what I later called "The Economic Sell Rule," which posits that if you find an asset you like better than one you now hold, you should swap. You estimate the anticipated rate of return (adjusted for risk tolerance) over your time horizon to appraise the desirability of new assets.

I ended up calling it the economic sell rule because each of three aforementioned sell disciplines had their own problems. Here's a rundown.

Price Targets

In a market of crazy valuations like the late '90s, many price targets get hit. If you're a long-only manager who has to stay fully invested, you can begin to run out of ideas on where to put money to work. Even if you can go both long and short, your portfolio can get shorter and shorter as price targets get hit on the long and short side in a sustained market rally. In a sustained decline, the portfolio gets longer and longer. This is an implicit bet on mean-reversion, which undoubtedly happens, but often not soon enough.

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David J. Merkel, CFA, FSA, is a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. Previously, he managed corporate bonds for Dwight Asset Management. At time of publication, neither Merkel nor his fund had any positions in the securities mentioned in this column, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Merkel cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send your comments to [e-mail].

Analyst Certification: All of the views expressed in the report accurately reflect the personal views of the research analyst about any and all of the subject securities or issuers. No part of the compensation of the research analyst named herein was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the research analyst in this report.

Merkel is employed by Hovde Capital Advisors LLC (the "firm"), a registered investment advisor with its principal office located in Washington, D.C. The Firm and/or its affiliates have or may have a long or short position or holding in the securities, options on securities, or other related investments of the issuers mentioned herein.