The Art of Execution: How the World's Best Investors Get It Wrong and Still Make Millions in the Markets by Lee Freeman-Shor (2015)

Lee Freeman-Shor picked 45 top investment managers and allocated $20-150 million to each, asking them to invest in just 10 of their best ideas during a seven-year period starting from 2006. He later analysed all the investments (1,866 in total) and trades (30,874) and what contribution they made to each stockpicker's performance.

Perhaps not so surprisingly(at least for me) was the fact that only 49% of investments actually made money (the author, unfortunately, does not provide details on how those investments compared to a sector or market performance as a 10% gain in a tech stock when the peers went up by 40% is hardly a winning stock picking). The author notes that some of the managers were right just 30% of the time (I guess part of the reason is the chosen period over which managers had to invest as markets went through one of the worst periods in their history at that time).

What is quite surprising, though, is that even with less than half of investments making money, the overall performance of those managers was positive. In other words, they made money on portfolios where more than half of positions lost money. The way to achieve it was by keeping losses fairly small and letting winning positions earn disproportionate gains.

One of the central ideas of the book is that great investors are not those who have great ideas but who can make the most returns from those ideas that work and minimise losses from mistakes. A similar idea was made by some famous investors like Soros and Druckenmiller, who are quoted as saying that 'it does not matter how often you are right or wrong, it is how much money you make when you are right and how much you lose when you are wrong that matters'.

The discipline is as crucial as the actual research and stock picking for successful investing, according to the results of the study.

According to Freeman-Shor, there are three types of investors depending on how they treat losses, and there are two types for dealing with winning positions. When a stock is falling, managers picked by Freeman-Shor either did nothing ('Rabbits'), quickly sold ('Assasins') or bought more after a serious correction ('Hunters)'. According to the author, the worst performers were Rabbits who tried to convince themselves that the original thesis hadn't changed, thus, little needed to be done. They saw some of their stocks losing 50-70% and were not able to recover the losses or failed to invest in better opportunities having capital stuck in 'dead positions'.

Two other types of investors ('Assasins' and 'Hunters') did better. Freeman-Shor suggests taking a serious review of the stock after a 20-25% drop - if the thesis has not changed much, he suggests adding or selling out if the case has gotten worse.

As for winners, investors are either too soon to sell ('Raiders') or are able to stay with the position long enough to take advantage of the rise in the stock ('Connoisseurs'). Key reasons for selling too soon: 1) Instant gratification ('It feels so good'); 2) Need for a change ('I am bored'); 3) Lack of patience or 'Frustration' (although the last reason looks very similar to the first one). All these are reasons deal with human psychology and become more acute when investors face more signals and notifications.

'Connoisseurs', on the other hand, sold parts of their winning positions over a relatively long periods of time and managed to maximise returns while fighting the temptation to take profits too quickly.