Low portfolio turnover is not an inherent virtue and can lead to underperformance.
While investors spend most of their time and energy identifying opportunities, knowing when to sell is an equally important part of long-term success.
As selling at the right time can have as large an impact on performance as buying at the right time, questions are intensifying about whether it might be prudent for investors to reduce exposure to the market’s recent high-flyers, such as the Magnificent Seven tech titans.
For global growth equity investors, evaluating a company’s fundamental prospects requires a deep understanding of its competitive advantages and growth potential – especially for emerging growers in their early stages. Usually, these take a long time to develop and become entrenched, which makes a long-term mindset essential.
However, this long-term mindset should not be misconstrued as complacency or a plan to buy and hold for a long period. The sources and nature of growth drivers are continuously evolving and changing over time. Long-duration growth companies, after all, are not common.
Low turnover can be detrimental
When predicting the direction of growth stocks, the market is often over-optimistic, thinking trees can truly grow to the sky, or overly pessimistic, believing returns will ultimately revert to the mean. Stocks suffering from over-optimism need to be weeded out, while stocks experiencing over-pessimism can turn into long-term winners and should be backed with additional capital. This is why our global equity team does not follow a strict ‘buy-and-hold’ approach.
Additionally, low portfolio turnover is not an inherent virtue. On the contrary, the more rapidly the world changes, the more it can be seen as a detriment to long-term outperformance.
The pitfalls of a strict buy-and-hold approach are obvious after considering the history of the corporate world. For example, many growth darlings that dominated industries eventually lost leadership because of new technologies, new competitors, or a new macroeconomic environment. Examples here include Blackberry and Yahoo. It would be an act of complacency – if not arrogance – to assume our investments at any point in time will justify all their underlying theses.
The most successful companies over the long term have been able to innovate, evolve, and reinvent themselves. They string a sequence of great business ideas together to create wave after wave of strong growth. For example, Mercado Libre, Latin America’s largest online marketplace, continued to innovate by creating an ecosystem of additional product offerings around its ecommerce platform, including payment solutions, logistics, financing, advertising and software services.
The risks of selling too early
The sell discipline is one of the most complex, and least understood parts of the investment process. A position is primarily sold for the following three reasons – to fund more attractive growth opportunities, to realise gains, or to reflect a change in fundamentals that alters the investment thesis. Great growth ideas can deliver strong returns for long periods of time, so it is crucially important that a sell discipline accounts for the risks of selling too early as much as holding a stock after its key growth drivers have matured.
Looking at our portfolio today, our views are often sought on whether we are nearing the end of the runway for many of the world’s most exciting growth stories – particularly those in the high-profile Magnificent Seven.
Here, the most discussed name is undeniably Nvidia. While Nvidia’s share price has increased almost 200 per cent over the past year, there are reasons to remain optimistic about the company, as it is still the best way of benefitting from the AI infrastructure capex boom. The revenue increase Nvidia has experienced over the last year from its data centre business is unprecedented, up from $15bn a year ago, to expectations of $90bn next year. The world is entering the fourth era of computing with generative AI and the investment opportunities are only just emerging.
Innovation has also sparked strong share price rises for shining lights in the healthcare space, namely Novo Nordisk and Eli Lilly, which have new treatments for chronic diseases such as diabetes and obesity. The fact the GLP-1 medicines developed by these companies also contribute to reducing heart attacks and strokes further increases the addressable market and makes it more likely insurance companies and governments will reimburse for these drugs.
There are a number of potential catalysts on the horizon for Novo Nordisk, which could drive growth further over the coming years. As for Eli Lilly, it has a strong R&D pipeline and only a few patents set to expire in the next decade. For the present time, the main concern is that these companies simply cannot manufacture enough of the GLP-1 drugs to meet global demand.
Only by having a clear and strong sell discipline can a portfolio regularly free up the capital to back the best long-term growth compounders and constantly seek fresh new growth opportunities.
Mark Baribeau, portfolio manager of the PGIM Jennison Global Equity Opportunities Fund
