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Portfolio Concentration - Sleep With One Eye Open
Investment Strategy | 3 Comments | Fri 15 Apr 2011
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Value investing can appear to be quite easy: thoroughly analyse a business and its risks and then ensure the price paid offers an adequate margin of safety. Many advocates postulate that because the analysis has been thorough and a margin of safety has been incorporated, intelligent investors can then concentrate their capital in their best ideas ("Why invest in your sixteenth best idea?"). However we highlight reasons why even seemingly-diligent analysts can make poor investment decisions that could prove catastrophic in a concentrated portfolio.



Comments

1.
On 18/04/2011 21:56:00, Colin Farrier wrote:
Portfolio Concentration
Diversification: I do believe in a modest amount of diversification or else would I put all my money into the stock of the company at the top of my shortlist? However I have been up to 25% in that top stock.
Selection process: I have a selection process that uses data from REFS going back 10 years for each company. Assuming that the data is consistent within and between companies then I have built a model of what has happened over the immediate past and I make a small assumption that this will roll forward for the next year. If in practice it does not then my model for this company is broken and I want to sell. Since the model has much higher performance than the average company then a small degradation can be still too small to notice for the analysts who affect the market price and I may sell at the ‘current price’. This sell early can also be considered some safety margin.
Short List: If my shortlist only has, say, two or three companies, how should I allocate capital at the next economic downturn? I still believe that a large proportion of investment ready capital (after allocating sufficient cash to a reserve) should be allocated to the number 1 company followed by a smaller amount to number 2.

2.
On 20/04/2011 17:05:42, Dermot Driscoll wrote:
It is often stated that one should not allocate more than 5% of a portfolio, including cash, to any one share (see Black Swans eg BP and Macondo)

3.
On 21/10/2011 12:50:49, Anonymous wrote:
Attached is the open letter sent by former Olympus CEO, Woodford to the Chairman/Board. If true, these events are stunning and the following questions are unavoidable for any serious investor: Could I have spotted this? What else could the board choose to conceal without my knowing? The answers to these questions are distinctly discomforting. Olympus is held by at least two highly regarded value investors. With all of this in mind, it is worth re-emphasising that concentration of capital into a few favoured positions is not all it is sometimes cracked up to be.

http://graphics8.nytimes.com/packages/pdf/business/20111018/letter-text.pdf

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