To concentrate? Or to diversify?
This has really been on my mind a lot lately.
Buffett says diversification is just an insurance against ignorance.
Which is really a fancy way of saying that if you’re not entirely sure, or if you think you are sure but am concerned that the world may throw you a curveball, then diversification would help cushion any potential road bumps. But it works both ways. I don’t think it’s possible to get really really amazing returns in the long run if one diversifies too much.
Ackman’s Pershing square has what… $10billion under management? And he holds less than 12 names at any 1 time. And even that is misleading cos most of the capital goes to the top 5 or 6 usually. But he has a return of >50% in 2019 to show for.
Bill Miller really scored in 2019, with a +120% thereabouts, and he’s also rather concentrated. Most funds find it really hard to consistently beat a passive index like SPY cos they really are closet indexers. They can’t deviate too much from the big index constituents, for fear that if they make 1 mistake, their returns would render the year a goner and they’re out of the game permanently i.e. investors say bye bye.
So amongst all the names that make up an index, they have to pick the winners… AND position size it accordingly into the winners such that the overperformance can cover fees and yet, still beat the index. Which is really crazy if you think about it.
At least I don’t have that problem. I just want whatever works best in the long run.
With these thoughts, I’ve decided to set up a new concentrated fund. I’ve already applied and it just got approved and up and running under InteractiveBrokers. Prob going to start off by funding it with $100k SGD first, and scale up with time.
I’m really just curious to see how it’d pan out. I’ve decided to run this under a wholly new fund instead of my existing portfolio, so that the performance results would be separately and accurately tracked by IB, so that I can see how an uber concentrated fund would turn out.
Yep, that’s what I’ve been busy with.
Naturally, the 5 names that I’ve come up with, are already existing positions and/or previous positions that I’m already pretty familiar with.
For a concentrated fund, I’ve also immediately eliminated ideas that I think may have a favorable risk-reward ratio, but are otherwise small caps or too volatile or dependent on a certain scenario playing out.
I can’t have a company that occupies 20% of my portfolio dropping 30% in 1 day.
So lovely companies that I really like, like ATXI, ain’t even up for consideration.
It’s up >110% since my post, in less than a year, and I’m still waiting for FDA approval.
Having said that, with the current state of affairs (by that, I mean the amount of liquidity in the system), I’ve noticed that even the big caps can have pretty crazy volatility.
FB was a -7% in 1 night right after it’s earnings release. AMZN “melt-up” almost 10% in a single day after beating earnings estimates, making Bezos a really happy man. I read that he had a paper gain of like $18billion or something in 1 day after earnings release. Mind boggling.
I guess that’s the risk of running a concentrated portfolio. Mark Howards says you can’t have the possibility of outsized returns, without taking on the risk of huge underperformance.
I’ve explored several ways to hedge, but… gee, I dunno. How is it possible to hedge against a -7% or -10% drop in a single day? Probably nothing much one can do. Liquidity is probably the best hedge.
Anyhow, after spending countless late nights and man hours pouring over my positions, I’ve come up with the final team.
Boy, this must be how Pep Guardiola feels at Barca. When you’ve to bench top talents that can stroll into any other 1st team at other clubs.
The benefit of this whole exercise is that it really compelled me to compare. Like really sit down for hours and compare the valuation of 2 companies that are otherwise king pins on their own, and pick 1.
Kinda like having to choose between dating Margot Robbie or Gal Gadot. You pray that you never have to make that choice.
Without further ado… here’s my 1st team that’s going to play against SPY:
- Visa (V)
- Broadcom (AVGO)
- Bausch Health (BHC)
- Tencent (0700)
- Agilent Techologies (A)
Maybe if I’m in the mood for it 1 day, I’d write a thesis for each of the 5 generals. But this post is not for that.
As one can see, none of the above names, even the reserves, are small players. They’re mostly dominant 1 way or another, within their respective industries.
Amongst the 5 generals, only Agilent Technologies is going to be an entirely new position. I’ve owned at 1 point or other, or still currently do, the other names in various position sizes.
But this exercise REALLY forced me to sit down and stare at the names in great detail, and compare really hard. I guess part of the criteria also involves my familiarity with the company. For eg. there’s a real case of AMZN ending up beating BHC or really, all 5 generals… but I’ve decided to go with what the companies that I think I understand better. That’s important because… this isn’t going to be just a buy-and-hold portfolio, come what may.
Which leads me to my next and last point.
The positions will be scaled in and up with options, and I intend to use options to adjust the position sizing accordingly. I think I have a competitive edge in this regard.
So the consideration here is not merely company fundamentals specific, but I do consider other factors like the option premiums available for the company and what I’m going to do with them. (AVGO, BHC, 0700 and A’s option premiums are ok-ish… V’s option premiums are kinda sucky cos of the low volatility)
Which is why I can’t simply run a hypothetical, retrospective study on the 5 names to figure out how the portfolio would’ve done. i.e. I can’t just choose a time frame of say 1 year ago, check the share price then vs now, and calculate the returns.
Cos I think what I do with the options, would feature heavily in the overall performance.
The 5 generals are also not going to be permanently in the 1st team. Otherwise, why have a reserve list?
So there we go. I hope to report stellar results in the long run, in which case, I might eventually tilt towards a purely uber concentrated portfolio. If it goes south, well, at least I’d know how much to diversify again.
So let’s go. Godspeed.
(It’s hard but I think I’d go for Gal Gadot, simply cos I like the alliteration)