In the academic literature of investment it is virtually impossible to justify running a loss-making position. The fact of doing so is to fall into the traps that behavioural finance describes so plausibly - status-quo bias, mental accounting, loss aversion. In a sentence, these say that investors stick with their status quo because the disadvantages of change seem greater than the advantages; that this is linked to the mental accounts investors set up when they make a purchase, where their natural reference point is their buying price; and that aversion to realising losses is strong because doing so 'proves' they were wrong to make the investment in the first place. As a result of this phoney thinking, investors' returns end up lower than they would be with clear thoughts.
There is much to be said for these notions. Yet I'm happy to question the behavioural literature because the theoretical reasons for being reluctant to sell rarely tally with my thoughts when I am running a losing position.
Implicit in the theory of behavioural finance - and occasionally explicit - is the idea that investors are lousy at being honest with themselves; that they will indulge in all sorts of mental legerdemain to avoid the truth. Granted, self-delusion is a familiar enough failing and it applies to investors too. Yet much of the time honesty is not so very difficult and many of us are sufficiently sensible and confident to understand that we are perfectly capable of making errors. That means mistakes will happen and bad calls will be made. We accept that and get on with it.
On, then, to the specifics of Ladbrokes and Air Partner. Why am I still holding these when both stocks have fallen through their stop-loss trigger points? Obviously, hindsight tells me it would have been lovely to have sold the fund's holding in Ladbrokes when the stop-loss was triggered at 182p about a year ago. That would have avoided £7,800-worth of losses that have since accumulated. But I didn't sell and we can't rewind the clock.
Yet each time Ladbrokes' share price has sunk further I have speed-checked the company's situation and have concluded that holding on was sensible; that some recovery in the share price was more likely than further losses. Each time I have been proved wrong, although that does not necessarily make each decision to hold on a bad one.
Take the latest instance - Ladbrokes's third-quarter figures for 2014, announced in late October. The book-maker's bosses are increasingly confident that the company has finally sorted out its online gambling platform, particularly its mobile app. In the third quarter - and helped by the final phase of football's World Cup - underlying digital revenues grew 23 per cent, driven by a doubling of the amounts wagered via Ladbrokes' mobile app. Overall, the company's £33m operating profit for the quarter was almost double last year's comparative period; net debt fell 5 per cent to £403m in the quarter and management reiterated that the full-year dividend would be 8.9p. That payout, which should just about be covered by accounting earnings and more comfortably covered by cash-flow generation, will yield 7.7 per cent with the share price at 115p. Despite all this, the share price rallied briefly, then continued the descent that began in March 2013.
The situation at aircraft broker Air Partner is a bit different. The share price crumpled when I was away last month. I returned to find that it had dropped 22 per cent in five days during mid-October, taking it through the stop-loss level. There was no catalyst for this. The most recent piece of news was an uninspiring set of first-half results for 2014-15 announced in late September. It had been expected for some months that the figures would be dull. Underlying pre-tax profit dropped from £2.7m to £1.1m as the main division - hiring commercial jets - suffered from a distinct lack of one-off business. Demand to hire private jets was not much better. Yet the nature of Air Partner's business is that the order book will be minimal and nothing that's happening now it hasn't seen before. Meanwhile, it has £18m of cash - versus a market value of £28m for its equity - to see it through and to pay a likely 20.7p dividend (cost £2.1m) that will yield 7.3 per cent with the share price at 275p.
So in both instances some recovery in the share price seems more likely than further falls. Therefore it makes sense to hang on because a rise in, say, the price of Ladbrokes shares will be every bit as useful as finding a new holding whose price goes up the same amount - and probably much easier to achieve. Both would benefit my income fund by an equal amount. And that's the crucial thing - what happens to the fund. Everything an investor does is subservient to the performance of the fund. Now, is that pig-headed or rational?
