Portfolio Concentration

[Graham Osborn]

 

Time will tell, but imho wealth is created by concentrating in good ideas, as long as you don’t lose money doing so. Otherwise what’s your edge over simply indexing (when valuations are reasonable)

 

Many have had phenomenal returns with a large portfolio.  Lynch owned on the order of hundred(s) of stocks and he killed the index. So did Schloss.  Even buffett had around 100 holdings in the 60's.

 

I think concentration on half dozen stocks should absolutely be value plays. That is they should be sure bets on undervalued assets -- not earnings.

 

True, but that's not what the OP was asking.  He was asking about concentration limits - the max % you should allow for given position.  For Buffett in the BPL days that was 40% (market/ assets vs cost/ assets).  I don't believe he ever prescribed a rule for cost/ assets, but looking at Berkshire's insurance portfolio in the 70s it was definitely up there around 20% at times.

 

For me max cost/ assets is 20%.  To calculate the right level of diversification for you you need to estimate the average upside for an idea, the probability of that upside, and same two variables for the downside.  Then you set the threshold probability of achieving the expectation, which for me is 95% (assuming the downside is acceptable).  If you suck at picking stocks, you need more diversification.  And if you are doing higher-uncertainty stuff like venture capital you need much more diversification - typically at least 80 investments for an investor with average selection ability.

 

For me I say my target stock is a 10X over 10 years and I assume my probability of making that selection in any given case is around 20%.  If you build in a margin of safety so your downside is 0.5X-1X, that math is pretty attractive over a 10-year period.

 

The people with truly insane IRRs are the superangels with really good selection ability and cyclical tailwinds.  I think Chris Sacca's IRR for lowercase was around 57%.