Your 2014 portfolio return

[RichardGibbons]

Can one stock with a put be less risky than owing 10 stocks? I would answer definitely yes.  The more stocks you add, if you are a good stock picker, the more opportunity cost you add to your portfolio.  The 5% it costs you to buy a put on your one-two-three best ideas might be much cheaper than the 20% hypothetical opportunity cost of adding your next seven to nine best ideas to your portfolio.  You must be okay being wrong from time to time, always keeping in mind what is your absolute dollar-value downside risk, assessing whether or not you are okay with your exposure.

 

You fool yourself when you think that way. See it as 50% of your networth in call options and then ask yourself if this is a prudent thing to do. 2 full losses after one another will wipe out 75%, after 3 you start from 12.5% of your networth again.

 

This is not the same as 50% of your net worth in call options.  It's the equivalent of 5% of your net worth in call options.  Suppose you have 50% of your net worth in stock, and that's hedged by 5% of your net worth in at the money puts.  The worst scenario is that you have to exercise the puts because the stock falls.  In that case, you lose 0% on the stock, and 5% on the puts (equivalent to putting 5% in calls, and having them expire worthless.)

 

[moody202]

 

This is not the same as 50% of your net worth in call options.  It's the equivalent of 5% of your net worth in call options.  Suppose you have 50% of your net worth in stock, and that's hedged by 5% of your net worth in at the money puts.  The worst scenario is that you have to exercise the puts because the stock falls.  In that case, you lose 0% on the stock, and 5% on the puts (equivalent to putting 5% in calls, and having them expire worthless.)

 

Exactly -- I'm not sure how you blow up in this scenario as some others on the thread are claiming.

[cmlber]

The whole premise of investing in only your best idea because it has 100% upside while your second best only has 50% upside has some major flaws. 

 

First, its impossible to know with such precision how undervalued something is, so knowing in advance what your "best" idea is will generally be very hard.

 

Second, you haven't given any thought to the opportunity cost of not holding your second best idea when the market closes the discount on the second best idea at a faster rate than the first best idea.  After all, the whole reason something is cheap is because of an inefficiency, why is it necessarily true that something that is "more undervalued" will always perform better than something that's less undervalued?  The answer is, it isn't. 

 

On average that may be true, but if you take one bet every year or two you will have a very small sample size, so it's probably a bad idea to think about averages. 

[frommi]

Can one stock with a put be less risky than owing 10 stocks? I would answer definitely yes.  The more stocks you add, if you are a good stock picker, the more opportunity cost you add to your portfolio.  The 5% it costs you to buy a put on your one-two-three best ideas might be much cheaper than the 20% hypothetical opportunity cost of adding your next seven to nine best ideas to your portfolio.  You must be okay being wrong from time to time, always keeping in mind what is your absolute dollar-value downside risk, assessing whether or not you are okay with your exposure.

 

You fool yourself when you think that way. See it as 50% of your networth in call options and then ask yourself if this is a prudent thing to do. 2 full losses after one another will wipe out 75%, after 3 you start from 12.5% of your networth again.

 

This is not the same as 50% of your net worth in call options.  It's the equivalent of 5% of your net worth in call options.  Suppose you have 50% of your net worth in stock, and that's hedged by 5% of your net worth in at the money puts.  The worst scenario is that you have to exercise the puts because the stock falls.  In that case, you lose 0% on the stock, and 5% on the puts (equivalent to putting 5% in calls, and having them expire worthless.)

 

It depends on the strike price of the put option. Earlier in the thread we talked about hedging with a put option to limit losses at 50%. When you do it with ATM puts its a whole different story, but you can`t ignore the cost of leverage for this case, because ATM options normally carry a lot of that. This can make sense and i can agree that its probably safer with 1 stock where you limit losses at 10% than going with a diversified portfolio. Sounds a bit like a barbell approach which Taleb speaks about in Antifragility. But when i understood it correcly, jmp8822 hasn`t achieved his returns that way, right?

 

 

[Mephistopheles]

The whole premise of investing in only your best idea because it has 100% upside while your second best only has 50% upside has some major flaws. 

 

First, its impossible to know with such precision how undervalued something is, so knowing in advance what your "best" idea is will generally be very hard.

 

Second, you haven't given any thought to the opportunity cost of not holding your second best idea when the market closes the discount on the second best idea at a faster rate than the first best idea.  After all, the whole reason something is cheap is because of an inefficiency, why is it necessarily true that something that is "more undervalued" will always perform better than something that's less undervalued?  The answer is, it isn't. 

 

On average that may be true, but if you take one bet every year or two you will have a very small sample size, so it's probably a bad idea to think about averages.

 

Of course, nobody can calculate with precision, but if two companies have a significant difference in undervaluation, it may be advantageous to bet more on one than the other. The difference may not be so obvious between your best and second best ideas, but perhaps between your best and sixth best ideas.

 

And sure, less undervalued companies may outperform more undervalued ones in the short term. But then again, even overvalued companies can outperform undervalued ones. It's not so possible to predict the behavior in the short term, so might as well bet on what's more undervalued.

 

Allow yourself a margin of safety. So if you think one idea is 40% of iv and another is 45%, then obviously you shouldn't go all in on the first.

[innerscorecard]

I've been around here long enough to see a number of posters similar to yourself come and go.  People will come on and claim they have this incredible market beating strategy and they're so much smarter than everyone else.  Then suddenly they disappear to never be heard from again

 

Are you referring to ERICOPOLY's recent lack of posting? ;D

[oddballstocks]

I've been around here long enough to see a number of posters similar to yourself come and go.  People will come on and claim they have this incredible market beating strategy and they're so much smarter than everyone else.  Then suddenly they disappear to never be heard from again

 

Are you referring to ERICOPOLY's recent lack of posting? ;D

 

No, when I wrote this I was thinking of HarryLong and a few others of his time.

[frommi]

This is not the same as 50% of your net worth in call options.  It's the equivalent of 5% of your net worth in call options.  Suppose you have 50% of your net worth in stock, and that's hedged by 5% of your net worth in at the money puts.  The worst scenario is that you have to exercise the puts because the stock falls.  In that case, you lose 0% on the stock, and 5% on the puts (equivalent to putting 5% in calls, and having them expire worthless.)

 

I lust looked it up for some stocks that i was interested in, and i found none where that would be possible. Either your cost of leverage is above 10% or you can not limit your losses at 10%. I would love to find a bet where its possible to have the annual cost of leverage <5% and the maximum downside is 10%. And then of course it must trade at 50% of IV. Show me!

[rayfinkle]

back down to earth-- blended for accounts I actively manage I returned ~0% this year. Net impact of a few wins and several (in hindsight oversized) positions moving against me. I think the latter category are cheaper now, but unfortunately may be lacking in catalysts. trying to gather some good learnings from this result. First take:

-Unreal busy at work + new baby = tough to give investing the TLC / thought space it needs. May be better to outsource...

-Need to set some hard rules for position sizing...after weeks of diligence on a company it's easy to get "deal hungry"

-Need more clear thinking on "time arbitrage." Much of what I invest in falls into the category of hated untouchables (to institutional investors at least)--too small, cloudy accounting / poor screening, boring businesses, etc. Very tough to be patient sometimes--especially if positions are oversized

 

Fun learning though! Thanks to the board, in particular packer, eric, oddball

[Haasje]

I'm in the bottom 4.5% :) But I'm sure if I keep working on ideas and be patient I won't be every year, even though it's a tough crowd. 

 

[merkhet]

I've been around here long enough to see a number of posters similar to yourself come and go.  People will come on and claim they have this incredible market beating strategy and they're so much smarter than everyone else.  Then suddenly they disappear to never be heard from again

 

Are you referring to ERICOPOLY's recent lack of posting? ;D

 

No, when I wrote this I was thinking of HarryLong and a few others of his time.

 

If I remember correctly, HarryLong slinked away because, despite loudly proclaiming his market crushing returns, he was never able to provide anyone with actual evidence of his track record. ERICOPOLY, on the other hand, has a 70% CAGR verified by Parsad himself.

 

I suspect that much of the pushback on jmp8822 comes from the fact that he is (1) new to the board, so there is little to no insight into his investment process from previous threads, and (2) he hasn't provided anyone with proof (to my knowledge).

[CorpRaider]

Haha.  Please someone be kind enough to remind me of this in the next bear market (I will be around; fates willing and the creek don't rise).  New contrarian indicator:  number of posts/length and/or existence of summary of annual returns survey thread.

 

 

[alertmeipp]

They key after losing money is to learn from your mistake.

 

I find it very hard. It's like a personality thing. I shall overcome. A checklist helps!

[RichardGibbons]

Sorry Frommi, I missed that you were talking about buying puts 50% out of the money.  In that case, you're right of course -- if you miss a couple times, you're screwed.

 

I think you won't find a cost of leverage below 5% annually very often.  Perhaps in some ETFs, but even then it would be hard.  It's pretty hard to think of a security trading on an exchange that has such low volatility....

 

 

[Rainforesthiker]

With regard to concentration / diversification I believe there are times when one should (or can) be more concentrated and times when one should be less concentrated, this being largely dependent on the degree of irrationality in the market and hence the degree of mispricing presented in the market. 

 

In the 2011-2012 time frame I had 80% of my stock portfolio in 3 positions, these being BRK, AIG and BAC (I guess somewhat similar to what the jmp822 poster had that others are criticizing).  I felt that at the prevailing prices the degree of risk in each of these was very low.  With BAC and AIG trading at significant discounts to tangible book, I thought that further downside was limited.  Also, I felt sure that their business franchise was intact and that reversion to the mean would occur (unlike SHLD for example where I have no such confidence).  Also, although it is counterintuitive, I view a company as much safer after a major blowup, as new management is not likely to make the same mistakes, there is more regulatory oversight, incredibly cheap prices, etc.  Also, I felt confident because I knew WHY the market was mispricing these stocks - there was a psychological rationale of fear and panic that I could point to to understand why the mispricing was there. 

 

At the current time I am more diversified, although the above 3 stocks are still about 55% of my portfolio.  I intend to further diversify a bit because the above 3 are not the bargains they once were, and hence the risk of being concentrated in them has increased a good bit.  In my investment philosophy, if I can understand from my knowledge of human behavior / psychology exactly WHY the market is mispricing something, I feel much more confident in larger position sizing and heavier concentration.  A current example of this is what the GM recalls did to GM stock / warrants .  The overreaction to oil prices could be another example (although I don't understand oil that well).

 

I do feel that in general having 5 - 10 positions or more is quite a bit better than having just 3.  However, sometimes the market presents opportunities where you can consider taking a big position in a stock or just a few stocks.  Buffett at one point had 40% of his portfolio in American Express during the salad oil incident.  If BRK ever got back to trading at book value like it did a few years ago, I would put 50% or more of my portfolio into it.  Those opportunities don't come along very often, but when they do they should be seized.  There is a great Munger quote on this that I am sure everyone knows.

 

My advice to the jmp822 poster would be:  You were very concentrated and did quite well in a certain time frame, but IMO that was because there was extreme market fear and irrationality that allowed heavy concentration to be successful with smallish risk.  However, you should also recognize when those conditions are no longer present in the market, and when that is the case it is much wiser to diversify a bit more and spread your risk a bit.

[Mephistopheles]

^ I believe Buffett was even more concentrated than that in AXP - about 75% of either his portfolio or partnership, if I recall correctly.

[Liberty]

Rainforesthiker, what you say makes sense to me (I was also heavily concentrated in AIG and BAC, though I got in later than some others here, so I didn't make as much), but giving examples of this stuff succeeding always works better in hindsight.

 

There are big mistakes that people make that, if you could go back in time and ask them their thesis and level of confidence at the time, they'd tell you similar things to what people said about BAC and AIG. Sometimes what seems like a sure bet no-brainer doesn't work. Sometimes you think you know enough about a situation, but you don't (unknowns unknowns). Etc. That's where not going to extremes of concentration - but still being concentrated enough so that your best ideas make a difference - can save you heartaches.

[cmlber]

The whole premise of investing in only your best idea because it has 100% upside while your second best only has 50% upside has some major flaws. 

 

First, its impossible to know with such precision how undervalued something is, so knowing in advance what your "best" idea is will generally be very hard.

 

Second, you haven't given any thought to the opportunity cost of not holding your second best idea when the market closes the discount on the second best idea at a faster rate than the first best idea.  After all, the whole reason something is cheap is because of an inefficiency, why is it necessarily true that something that is "more undervalued" will always perform better than something that's less undervalued?  The answer is, it isn't. 

 

On average that may be true, but if you take one bet every year or two you will have a very small sample size, so it's probably a bad idea to think about averages.

 

Of course, nobody can calculate with precision, but if two companies have a significant difference in undervaluation, it may be advantageous to bet more on one than the other. The difference may not be so obvious between your best and second best ideas, but perhaps between your best and sixth best ideas.

 

 

This is the point I'm making.  I'm a believer in concentrating, but one stock seems to go too far in my opinion.  I think there's a reason Charlie Munger says 3-4 stocks is enough but never quite goes so far as to say you only need a one stock portfolio.  Concentrating on your best few ideas makes a lot of sense.  If you think something is a 2.5-3.5x, and you think something else is a 2-3x, it's hard to say which one is truly "better" on its own, you should probably own both.  Sure if you have one amazing idea thats a 5x and your next best idea has 20% upside it makes sense to concentrate on only your best idea.  But practically speaking, you won't find yourself in that position.  Comparing your best idea to your sixth best you might find yourself there.

 

 

And sure, less undervalued companies may outperform more undervalued ones in the short term. But then again, even overvalued companies can outperform undervalued ones. It's not so possible to predict the behavior in the short term, so might as well bet on what's more undervalued.

 

 

The point I'm making is that it's true that over the long run, on average, the larger the discount to intrinsic value, the better your idea will perform.  But if you are making so few bets (one every year or two), you don't get the luxury of thinking about averages because your sample size will be so small. 

[Rainforesthiker]

Rainforesthiker, what you say makes sense to me (I was also heavily concentrated in AIG and BAC, though I got in later than some others here, so I didn't make as much), but giving examples of this stuff succeeding always works better in hindsight.

 

There are big mistakes that people make that, if you could go back in time and ask them their thesis and level of confidence at the time, they'd tell you similar things to what people said about BAC and AIG. Sometimes what seems like a sure bet no-brainer doesn't work. Sometimes you think you know enough about a situation, but you don't (unknowns unknowns). Etc. That's where not going to extremes of concentration - but still being concentrated enough so that your best ideas make a difference - can save you heartaches.

 

Yes I do understand what you say and agree to a large extent.  One can never be 100% certain about anything, especially where human behavior is involved.

 

However, just because someone has high conviction about something does not make it a good investment, or that person right.  Investors have varying skill levels, and varying degrees of awareness of human's innate cognitive and behavioral biases.  Also they may use more or less rigorous investing frameworks in their analysis.

 

I actually need to see a number of factors (or criteria) clearly in place to have high conviction about an investment.  IMHO, when these factors are all present, then I believe the investment is clearly one of high conviction; if any one of these factors is missing, then I don't have high conviction.  Other investors may get high conviction when only one of these factors is present, and in that case I think they are assuming a much larger risk of being wrong as you say.  With BAC and AIG (and BRK) all of the factors that I look for were clearly there.  I really thought my risk in those was negligible to non-existent.

 

These factors are:

1) variant perception - My fundamental (qualitative and quantitative analysis) indicates the business value is much higher than the stock price; a large margin of safety; this also includes the notion that underlying business franchise is sound and the current problems are both short term and solvable.  With BAC and AIG i thought that in a (extremely unlikely) worst case scenario of bankruptcy / liquidation my investment would turn out just fine.

2) inefficient rationale - I can point to clear irrationality in the market, e.g., some combination of fear, uncertainty, hatred of the business, loss aversion, short term thinking, that explains WHY the market is not pricing the business correctly.  I view this as the most important criteria of all.  There is a lot of power in crowd wisdom when the crowd is thinking rationally (which is the basis of EMT), and I really believe that in most situations there needs to be some clear identifiable irrationality on the part of the crowd to produce a reliable offset from a normally wise crowd result.  This offset from crowd wisdom produced by crowd irrationality creates the mispricing.  Thus I need to see clearly irrational crowd behavior to understand WHY the crowd is getting this wrong.

3) "wisdom of the crowd" from a select group of value investors.  When other value investors that I respect have taken positions in a stock at a certain price (and even better if the stock price has fallen further from that price), this provides added confirmation to me.  I have spent a good bit of time thinking about the "wisdom of the crowd" phenomena as it relates to stock market pricing.  The reason why stock mispricings occur is largely because of crowd irrationality which corrupts what should be a wise crowd result.  However, if I can select a smaller group of "truly wise" crowd participants, where this group is not susceptible to irrationality, then there is a degree of power/truth in that smaller wiser crowd.  This is very similar to a cloning strategy.  This would also be what efficient market theory (EMT) would actually look like (on a smaller scale), where every member of the crowd behaves rationally and bases his decisions on fundamental value.

 

As an example, it would be rare to never that I would have high conviction about an investment where I merely thought my fundamental analysis was producing a different price than the market (having only a "variant perception" above), absent some clear irrationality in the market that I could point to (an "inefficient rationale").  Or to put it another way, if someone analyzed a company and came up with the conclusion that "Hey, this is cheap!", they might have a high conviction about the idea.  I never would unless I could identify clear crowd irrationality to explain the mispricing.  I would also want to see other value investors that I respect reaching similar conclusions.

 

Thus I guess my point is that someone could reach the level of "high conviction" in an investment idea with a less reliable framework or thought process, and that will certainly lead to trouble over time as you point out.  If an investor uses a more thorough and rigorous framework to identify high conviction investments, IMO there is a much smaller chance of error.

 

[james22]

May I ask how old you are and what amount you are roughly investing compared to your income?

 

20s - 8x annual income.

 

In fact, the current market environment is what Adam Smith called a “kids market.” I’m referring to the pseudonymous author and his investment classic from the late 1960s titled “The Money Game.” Smith introduced the concept of a “kids market” to describe an investment environment in which the advisers and traders making the most money are those too young to remember the last bear market.

 

“Memory can get in the way of such a jolly market,” Smith wrote.

 

Smith created a fictional character called The Great Winfield, who exploited kids’ markets by only hiring investment managers who were not yet 30 years of age: “The strength of my kids is that they are too young to remember anything bad, and they are making so much money that they feel invincible. Now, you know, and I know, that one day the orchestra will stop playing and the wind will rattle through the broken window panes, and the anticipation of this freezes [the rest of] us” who are old enough to remember.

 

http://www.marketwatch.com/story/stock-market-risk-is-higher-today-than-it-was-in-the-dot-com-era-2015-01-09

[rkbabang]

Fidelity finally updated the performance page with the Dec 31, 2014 numbers. I posted this last year when I had an exceptional year, so I'll post it again this year when I under-performed the market by quite a bit.

[krazeenyc]

Fidelity finally updated the performance page with the Dec 31, 2014 numbers. I posted this last year when I had an exceptional year, so I'll post it again this year when I under-performed the market by quite a bit.

 

HumbleBrag! 35% compounded over 5 years is quite nice!

 

[rkbabang]

Fidelity finally updated the performance page with the Dec 31, 2014 numbers. I posted this last year when I had an exceptional year, so I'll post it again this year when I under-performed the market by quite a bit.

 

HumbleBrag! 35% compounded over 5 years is quite nice!

 

 

Yes I am very happy with my 5 and 10 year performance (actually about 9 3/4 years), but I was talking about the sub-par 2014 return.

[krazeenyc]

Fidelity finally updated the performance page with the Dec 31, 2014 numbers. I posted this last year when I had an exceptional year, so I'll post it again this year when I under-performed the market by quite a bit.

 

HumbleBrag! 35% compounded over 5 years is quite nice!

 

 

Yes I am very happy with my 5 and 10 year performance (actually about 9 3/4 years), but I was talking about the sub-par 2014 return.

 

29% compounded over 10 years even more of an achievement!  ;)

[writser]

Congrats, extremely impressive. Would you mind sharing your strategy roughly? Microcap / large cap? US / international? 5 positions or 50 positions? Heavy turnover? Sorry for all the questions, just trying to get a general gist of what you are doing.