Execution: An Overlooked but Critical Component of Performance Evaluation

Performance as a tool should not be limited to what we are used to using it for, that is creating monthly and quarterly reports, performance remuneration and snapshots as to how our investments are doing. The field of Investment Performance is underutilized more so than any field in the industry. One significant aspect of the investment process that is not formally documented and analyzed is execution. Execution can make a break a great investment thesis. Let’s remember that the investment thesis is the core of your long-term investment process. It is where everything begins and without a documented process, it becomes difficult to evaluate skill and in that skill evaluation, should lie execution.

Our execution analysis can be as diverse as our imagination allows us but for simplicity’s sake.  In this post, we will focus on three items:

• Thesis Management

• Price Entry Point

• Price Exit Point

Thesis Management

The thesis is the most critical component of the investment process. It is where the idea begins.  How well have we been able to execute this idea over time matters as well. From the initial set up of the portfolio (asset allocation/security selection), the management of the portfolio over time, and to the price entry/exit points into the selected securities, all these factors are critical to evaluating execution.

For instance, have we properly distributed the capital to required weighted asset classes, industry, or sectors; depending on what the thesis requires. In addition, thesis adjustments may be required during the portfolio’s lifespan. There are different reasons for this but being nimble and avoiding a static stance, will provide more opportunities to better the thesis:

• Did the economic landscape change that has impacted the thesis and slight changes may be needed.

• Has firm management found better ways to execute the thesis if it is adjusted to maximize profits.

Price Entry point

As great as an investment might look, it is critical we enter at the correct price entry point. Do we have to buy at the bottom, not at all. What is important here and what we should be focusing on in evaluating execution is have we entered into securities at favourable price entry points or have we overpaid for them, limiting our upside or even creating risk for loss.

At times it is difficult to say because you may enter into a position that seems at a high price but by factoring in the growth, after a few years, that price will have been significantly discounted. Performance is a look back tool and cumulating ex-post analysis over time, will provide you greater understanding of how well you executed your price entry point.

Price Exit Point

As important the price entry point is, so is the price exit point. There are many reasons to exit a position, just not to realize gains but if there are securities that we have selected based on our thesis with a certain expectation, we should be able to get the most out of them. Does that mean selling at the peak? Not at all. What we need to look at is how much more upside did we leave on the table when we exited, if there was a positive return. If exited too early and missed out on a significant upside, then yes, that would reflect poorly on our execution. If on the other hand we are exiting a position for a different reason, then the benefits of that change should be evaluated.  Perhaps we are exiting a position for tax reasons, or we may have found another security that better fits what we’re looking for and need to free up capital. A comprehensive, flexible evaluation is required.

What does performance tell us

Performance is always evolving and finding ways to identify how and why were returns generated are important. It is not limited to the investment industry; you can see it in all industries where every advantage is being sought through feedback tools to enable to identify opportunities not always sought.

Execution is an important part of the portfolio management process, and more thought should be put into it to see how well the team is working to better the firm and its investors. It takes time to evaluate the skill of a manager, and it does so as well for their execution. Only with time, as in all things, are we able to properly differentiate skill and luck (good/or bad).