Concentration

[kevin4u2]

I totally agree with you as I also feel very comfortable with a concentrated portfolio.  I have 3 positions which account for 47.64% of my portfolio (Philip Morris International, Fairfax and Bank of America) and my top 6 positions are 78.93%.  With a concentrated position, you need to be extremely certain  of it's prospects otherwise it can hurt!!!  :)

 

S

 

 

I have discovered that I feel very comfortable with a very concentrated portfolio. For example, I don't mind having positions that each make up 30%+ of my total portfolio. A dream scenario for me would be 3-5 asymmetric holdings and nothing else.

 

Anyone else feel this way? I know that many of us are investing in the same companies, but there seems to be a vast difference in how concentrated we are. It confounds that someone can love an idea so much, but then limit it to a 4% position.

 

WEB has just shy of 70% in his top 4 positions KO, WFC, IBM, & AXP (in that order)

[constructive]

Maybe I'm confused, do you do a clean slate every few months or something?  I'm saying I have positions in all stages of value realization.  Some are newly initiated positions, others are just in a holding pattern, and some are nearing IV.  So I'm selling down the IV ones to buy new positions, but I'm not going to sell off something that's in a holding pattern just because it hasn't reached IV yet.

 

The truth is I don't have a ton of ideas to implement that either.  I might add 10 positions over the year or less, and sell off a few.  So it's not a lot of activity at all, mostly just waiting.

 

No, but sometimes I take a week or two off from thinking about investments, and then start with a clean mental slate.

 

Your description of your investment style makes sense (to anyone who has read Graham). I was just struck by the comment that you don't have a clean slate when making buying decisions. I used to feel similarly and for me it was negative. I had a disorganized portfolio and made trades to improve it - now I envision the entire portfolio and execute that plan.

[constructive]

Your attitude probably makes you well-suited for microcaps, while mine makes me better suited for more liquid stocks. Naturally, liquidity also affects the appropriate concentration for the portfolio.

[SharperDingaan]

We very seldom stray beyond 3-4 equities, & have done so for many years. That said, we can offer some observations...

 

If you don't do this full time, most of us cannot realistically expect to 'know' more than 3-4 securities at any one time. To get the bulk of the diversification benefit they also need to be in different industries. 

 

You have to be comfortable with volatility; portfolio swings of 25%-40% are not uncommon.

 

You have to be looking for at least a double every 3 yrs; or a minimum 24%/yr compound return for the risk & management involved.

 

You have to be willing to materially overweight at inception, & spend the rest of your time reducing your risk. The unit price at inception is usually at/near its lowest, & in most cases you will be progressively selling down as the share price rises to recover your initial investment.

 

You should have a preference for equities that are either liquid, have an option market, or are likely to become marginable at some point in the future. You don't need to sell XYZ to recover your initial  investment, if you can borrow it instead.

 

You cannot expect to manage the portfolio passively. You must be willing to think for yourself, & be comfortable with holding contrary opinions. It will also help you to master the art of hedging.

 

SD

[Packer16]

In terms of concentration, I think it is for me a function of where I find the value.  I start with an industry (circle of competence) that I think is cheap (for example 2 yrs. ago radio broadcasters, 5yrs ago it was O&G) then I find the best positioned firms and the cheapest in the industry.  I concentrate on the best value above the micro-cap level of firm.  Since many of these firms are levered, I have learned a bit about HY analysis and use the bond prices to guide me to where there are discrepancies between the bond prices and the stock prices.  I look for low yielding bonds combined with high FCF yielding equities.  My current concentration is 60% in the top 5 and 85% in the top 10. 

 

The reason I don't hold all of my money in a specific firm/industry is I try to identify where the industry recessions are and invest in those segments.  Currently I like media (TV/radio broadcasters), leasing firms, banks, autos and insurance.  I currently have starter positions in gaming and telcos.  If the market hits any of these sectors I will rotate from the more expensive firms to the cheaper firms.  For example earlier this year I rotated out of some the radios and hospitality names into TV, banks and autos and from some leasors (containerships to MRI equipment and cargo planes).

 

I think your style has to match your personality.

 

Packer 

[king888]

Some private investors prefer to do an all-in for the past several years in AAPL

http://finance.fortune.cnn.com/2012/12/06/apple-stock-investing/

 

The story would be a lot different if they put it in Enron, Worldcom or Chinese-scam companies

[Kraven]

Some private investors prefer to do an all-in for the past several years in AAPL

http://finance.fortune.cnn.com/2012/12/06/apple-stock-investing/

 

The story would be a lot different if they put it in Enron, Worldcom or Chinese-scam companies

 

The sign of a bull market.  Reminds me of articles I remember reading around 1999.  There was one in particular that was really good and I kept it for years.  It revolved around certain investors who put their life savings in stocks like MSFT, CSCO, etc.  I remember one guy in particular.  He was in his late 50s at the time and he had put all his money into a few of the tech stocks.  The quote under his picture in the magazine was "I think I'm being conservative".  I wish I could find that magazine.  A few moves and my wife not understanding or appreciating the need to keep an old magazine and poof one day it's disappeared.

[Guest hellsten]

Some private investors prefer to do an all-in for the past several years in AAPL

http://finance.fortune.cnn.com/2012/12/06/apple-stock-investing/

 

The story would be a lot different if they put it in Enron, Worldcom or Chinese-scam companies

 

Very scary. Signs of a bubble:

They wound up buying Apple stock at $30 a share, and have stuck with it ever since, selling shares only to pay for their Honolulu condo and for vacations. They spend an hour or two every morning reading and discussing the latest Apple headlines, but nothing they've read to date has shaken their faith. "You know that scene in You've Got Mail when Maureen Stapleton confides to Meg Ryan, 'I'm very rich -- I bought Intel (INTC) at $6'?" Jeanne says. "Well, sometimes I feel like that's us."

 

I'm reading the Halo Effect and I'm sure much of what the book says applies to Apple and what the media writes about Apple. The Brooklyn Investor recently wrote 2 articles on Apple that I completely agree with:

http://brooklyninvestor.blogspot.com/2012/12/apple-is-no-polarioid-but.html

http://brooklyninvestor.blogspot.com/2012/12/why-i-left-apple-apple-is-speculation.html

[eclecticvalue]

Brooklyninvestor is an amazing writer. Those article sum up why apple wont do well unless they can adapt to innovate again instead of resting on their laurels.

[nkp007]

Apple isn't even that good of an investment. what is the upside? Best case scenario a double? Worst case scenario its market share starts to erode in the hypercompetitive space it is in and it falls in intrinsic value quickly. So, medium-high risk for medium-high reward. Not asymmetric at all.

 

It's popular because it's understandable. It's understandable because everyone sees or owns the products.

 

Wait, what were we talking about again?

[Guest deepValue]

I only invest when I'm really excited about an opportunity. I don't make opportunities that I'm excited about a 2% position; I put as much money as I can into it. It fits my personality, but not everyone can invest this way. It comes down to your personality, depth of research, and the kinds of companies you invest in (e.g., wide-moat companies vs little downside protection).

 

It's popular because it's understandable. It's understandable because everyone sees or owns the products.

 

I don't think Apple is understandable at all. It's too difficult to figure out how profitable the company will be in five years because the products it will be selling then do not yet exist. I think Apple could belong in a diversified portfolio, but not a concentrated one. Too much uncertainty. Just my two cents/brief tangent.

[nkp007]

I only invest when I'm really excited about an opportunity. I don't make opportunities that I'm excited about a 2% position; I put as much money as I can into it. It fits my personality, but not everyone can invest this way. It comes down to your personality, depth of research, and the kinds of companies you invest in (e.g., wide-moat companies vs little downside protection).

 

It's popular because it's understandable. It's understandable because everyone sees or owns the products.

 

I don't think Apple is understandable at all. It's too difficult to figure out how profitable the company will be in five years because the products it will be selling then do not yet exist. I think Apple could belong in a diversified portfolio, but not a concentrated one. Too much uncertainty. Just my two cents/brief tangent.

 

You're right. I should have said:

 

It's popular because its products are popular.

[Hielko]

One aspect that I'm missing a bit in this discussion a bit is that the amount of concentration should imo for a large part be a function of the idiosyncratic risk in a certain investment. You could have an awesome investment that still has a 50% probability of going to zero. Wouldn't make sense to put all your money in your best idea, if this is your best idea, no matter how big the upside. If you have on the other hand a super solid and safe business it might make sense to put a lot of money in it even though it's going to return a lot less on average than the business with binary outcomes.

 

I personally buy a lot of ugly businesses where the market does have some questions about the future of the industry. While I all think that they are a a good bets I think it would be a terrible idea from a risk management perspective to take an outsized position. They are not all going to work out. If someone on the other hand would be willing to sell me BRK tomorrow for $50/share I would probably buy as much as I could. But there are very few companies where I would be willing to bet it all on, and when BRK would actually trade for $50/share there probably is a decent reason/risk to not bet it all...

[txitxo]

I think that everybody who is concerned about concentration should make this exercise:

 

- Assume that you own N stocks every year

- Assume that the returns for any of those stocks can be described by Gaussian distribution with average R  and sigma dR

- Run 10, 20 and 40 yr simulations varying N and using your estimated values of R and dR. 

 

  Very few people will wish to systematically own 3 stocks after seeing the results.

 

Now, instead of a Gaussian, use a realistic, fat-tailed distribution which can certainly go to 0. You will see that it is very risky, as in permanent-loss-of-capital, to own only 3 stocks for decades. If it is only a short period of time, because you see an amazing opportunity, well above your average expected returns, then it may be worth the risk, but I would still do the numbers carefully. 

 

Seth Klarman has averaged ~20% per year, is managing >23B, and it is still able to find 20-30 stocks to invest in. It should not be that hard for retail investors.

 

[PlanMaestro]

One aspect that I'm missing a bit in this discussion a bit is that the amount of concentration should imo for a large part be a function of the idiosyncratic risk in a certain investment. You could have an awesome investment that still has a 50% probability of going to zero. Wouldn't make sense to put all your money in your best idea, if this is your best idea, no matter how big the upside. If you have on the other hand a super solid and safe business it might make sense to put a lot of money in it even though it's going to return a lot less on average than the business with binary outcomes.

 

Concentrated investing forces you the discipline of avoiding fliers, coin tosses, and lottery tickets. You really have to know what you are buying. It also self-regulates the amount of cash to have available for once-in-a-lifetime opportunities that seem to be appearing more than once in a lifetime.

 

I also like about concentrated investing, that there are always tempting but distracting cheap crappy leveraged companies available. But they involve too much psychic attention for my taste: too many surprises, and surprises are usually bad. That I learned the hard way following Klarman into RHI Entertainment (RHIE) a while back. Horrible.

 

Some catastrophic surprises that I avoided this year: PNCL, ATPG and LNET … and I have to say all of them were very, very tempting at the time.

[nkp007]

One aspect that I'm missing a bit in this discussion a bit is that the amount of concentration should imo for a large part be a function of the idiosyncratic risk in a certain investment. You could have an awesome investment that still has a 50% probability of going to zero. Wouldn't make sense to put all your money in your best idea, if this is your best idea, no matter how big the upside. If you have on the other hand a super solid and safe business it might make sense to put a lot of money in it even though it's going to return a lot less on average than the business with binary outcomes.

 

Concentrated investing forces you the discipline of avoiding fliers, coin tosses, and lottery tickets. Also it self-regulates the amount of cash to have available for the once in a lifetime opportunities that seem to becoming more common not less so.

 

I also like about concentrated investing, that there are always tempting but distracting crappy leveraged companies available but they involved too much psychic attention for my taste … they bring with them too many surprises, and surprises are usually bad.

 

It adds a nice filter for me. I ask myself, would I be willing to invest 25% of my fund into this company? If the answer is a quick no, then I save a lot of time by moving on.

 

 

[PlanMaestro]

One I thing I learned while working for an auto parts company: Kaizen.

 

http://en.wikipedia.org/wiki/Kaizen

There was a time when auto companies and their suppliers carried huge in-process inventories because they thought defects were statistical … when they weren't.

 

RR: Deming System, that is also relevant for the discussion on Finland's education system

http://en.wikipedia.org/wiki/W._Edwards_Deming#Deming_philosophy_synopsis

 

 

I think that everybody who is concerned about concentration should make this exercise:

 

- Assume that you own N stocks every year

- Assume that the returns for any of those stocks can be described by Gaussian distribution with average R  and sigma dR

- Run 10, 20 and 40 yr simulations varying N and using your estimated values of R and dR. 

 

  Very few people will wish to systematically own 3 stocks after seeing the results.

 

Now, instead of a Gaussian, use a realistic, fat-tailed distribution which can certainly go to 0. You will see that it is very risky, as in permanent-loss-of-capital, to own only 3 stocks for decades. If it is only a short period of time, because you see an amazing opportunity, well above your average expected returns, then it may be worth the risk, but I would still do the numbers carefully. 

 

Seth Klarman has averaged ~20% per year, is managing >23B, and it is still able to find 20-30 stocks to invest in. It should not be that hard for retail investors.

[zarley]

Seth Klarman has averaged ~20% per year, is managing >23B, and it is still able to find 20-30 stocks to invest in. It should not be that hard for retail investors.

 

I think you have your logic backwards here.

 

Seth Klarman, one of this generations best investors, and his team of managers/analysts is able to find 20-30 stocks to invest in . . . I think a retail investor working part time would be nuts to think they could match that.  I might know 20 decent companies well enough to own them, but I don't own them because the right price hasn't presented its self. 

 

I own 5 stocks in my brokerage account because I can't follow 100 stocks closely and I feel comfortable with the safety and future prospects of each.  If I'm wrong my returns will be volatile, but I can accept that. 

 

 

[Guest wellmont]

for most people a double is just fine in 5 years. there is a "special" group of characters here who would be terribly unsatisfied with that. note the small number of people who post here. in fact for lots of investors apple is a natural bet. it sells at a cheap p/e ratio. and you can put a lot of money to work. I think at times we forget that investors have different situations in front of them. this board attracts a lot of private investors and smaller money managers. they can and do implement different strategies than 95% of the equity investors out there. Some of them are young and haven't learned particular lessons yet. Some just are smart enough to make concentration work. they are very rare animals indeed.

[Guest wellmont]

a retail investor could do very well by just being on the right side of volatility. there are plenty of people who beat the snp every year without knowing the companies they trade that intimately. I know of what I speak. :) you just have to have a "roughly right" handle on the stocks you are working with. But the key is to buy when stuff goes down and sell when they go up. it's really that simple. I am not being flip. the "crowd" doesn't do that.

 

I know an 80+ year old guy who has been working as a money manager on wall street for decades. he beats the snp regularly by owning over 100 stocks at a time. And I can assure you he does not do in depth research where he knows the ins and outs on every one of these companies. what he has is very good intuition and judgement about people, and situations. and he uses those skills within a framework of some simple accounting and valuation skills. he could never ever write a 40 page sell side report that tears a company from limb to limb. but he has something that the guy who can write that report doesn't. an innate ability to manage money well.

 

there are many many ways to skin the money cat. think "rose blumpkin". also lots of people are just born with the Phil Carret "money mind".

[compoundinglife]

I think that everybody who is concerned about concentration should make this exercise:

 

- Assume that you own N stocks every year

- Assume that the returns for any of those stocks can be described by Gaussian distribution with average R  and sigma dR

- Run 10, 20 and 40 yr simulations varying N and using your estimated values of R and dR. 

 

  Very few people will wish to systematically own 3 stocks after seeing the results.

 

Now, instead of a Gaussian, use a realistic, fat-tailed distribution which can certainly go to 0. You will see that it is very risky, as in permanent-loss-of-capital, to own only 3 stocks for decades. If it is only a short period of time, because you see an amazing opportunity, well above your average expected returns, then it may be worth the risk, but I would still do the numbers carefully. 

 

Seth Klarman has averaged ~20% per year, is managing >23B, and it is still able to find 20-30 stocks to invest in. It should not be that hard for retail investors.

 

Seth Klarman only has around 3-4B of equities in his fillings, I would assume but don't know that the rest of the money that is not cash is in more illiquid investments that are probably out of reach for the average investor. He did alot with debt during the crisis and has mentioned real estate quite a bit too.  While I have only been following him for a few years it seems like someone trying to mimic just his equity positions would not do so hot. From what I have read it sounds like they have made alot of money in the past few years on things that people really needed to get rid of quickly and there was little or no market for and then they jump in big.

[PlanMaestro]

Best Ideas

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1364827

 

Abstract:     

We examine the performance of stocks that represent managers' "Best Ideas." We find that the stock that active managers display the most conviction towards ex-ante, outperforms the market, as well as the other stocks in those managers' portfolios, by approximately 1.6 to 2.1 percent per quarter depending on the benchmark employed. The results for managers' other high-conviction investments (e.g. top five stocks) are also strong. The other stocks managers hold do not exhibit significant outperformance. This leads us to two conclusions.

 

First, the U.S. stock market does not appear to be efficiently priced by our risk models, since even the typical active mutual fund manager is able to identify stocks that outperform by economically and statistically large amounts.

 

Second, consistent with the view of Berk and Green (2004), the organization of the money management industry appears to make it optimal for managers to introduce stocks into their portfolio that are not outperformers. We argue that investors would benefit if managers held more concentrated portfolios.

[bennycx]

Oh well.. for every paper that claims the benefits of concentration, there will be many others that claim the benefits of diversification..

[PlanMaestro]

Yes, there are many arguing for diversification on a Fama/French/Markowitz abstraction style. Not many have dealt with the issue of Stock Picking Ability versus AUM Incentives. Maybe you have one?

 

Oh well.. for every paper that claims the benefits of concentration, there will be many others that claim the benefits of diversification..

[JRH]

Best Ideas

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1364827

 

there are many many ways to skin the money cat.

 

It's interesting... Most people don't understand where their own outperformance comes from (when it happens).  I think the innate human reflex to outperformance is to feel that you have some innate talent, rather than that your results can be explained by your investing process, informed by the laws of statistics and accepting an appropriate degree of randomness.

 

Personally, my outperformance since 2009 (when a significant portion of my portfolio first became stocks, rather than mutual funds) is likely explained in that paper.  I've simply researched stocks being bought in considerable quantity (as a % of their portfolios) by Buffett, Berkowitz, Watsa, Pabrai, Ackman, etc..., and then copied their actions.  The only difference is that I have done this judiciously, further pruning the list to my own subjective liking and understanding.

 

I haven't backtested the theory, but it's quite possible I could have done just as well without so much as looking up what companies the tickers represented, if I only had quantitative portfolio criteria for making a composite "best ideas" portfolio from these investors.  Instead, I have spent hundreds of hours reading filings and message boards, listening to conference calls, etc...

 

It's an interesting thought and something I should probably look into.  I would welcome having that time back in the future.