Diversification vs Concentrated Portfolio

Hi, I am new here, just signed up. I have been investing in equities for last 2+ years, mostly by hear say or reading blogs. I have a fairly diversified portfolio (attached, with % allocation to various stocks and returns as on date), and I think they are far too many there :smile: ) across industries and market cap’s.

My doubt is what level of diversification is good? Am I having too many and will it be better to stick to maybe 20 stocks? Any suggestions thoughts around this will really help.
VP PF Review.xlsx (12.3 KB)

With the collective experience here, if there are any bad apples for long term which I should move out of, let me know.

Thanks
Varadharajan

As mind is fresh, I just wrote a piece of concentrated investing.

If I peek into your file of portfolio, I may ask these questions to myself:

  1. Banks, Pharma, Infrastructure, Airlines, Luxury jewellery and long tail. Do I understand all of them? For example renewable energy is not my cup of tea.
  2. Even if you want to diversify, chunk the themes. For example- why 5 banks, 5 pharma. Why not select one in each sector? Second theme will be diversify only on high public float or low public float? High public float will allow you to escape easily. Another theme should I go for low base companies like 200-500 cr MCAP.
  3. A bear case- as so many diverse companies are there what’s my action plan a. when stock fundamentals are worsening (how do I know and jump the ship). b. in case market crashes which one to sell and keep.

To confirm whether your diversification works, you need to know CAGR. If the number of 30% in file is one year then it’s an excellent return for such a diversified portfolio.

I guess you run a business understanding, should be able to prune quite a few.

Good luck.

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Thanks for taking time to share your thoughts. I just started buying into stocks for last 2 years, and the CAGR would be about 14-15%. I buy on a monthly basis saving from salary, basically on hear say, friends advise and what looks like a good bargain at that point of time, without understanding or analyzing too much into the business fundamentals. That explains why I have so many companies all over the place :slight_smile:

Will review the portfolio basis your suggestions, thanks again for your reply, much appreciated!!

Over the last 8 years, I have swayed between having 50 stocks to 3 stocks to 27 stocks in my portfolio.

I moved from 50 to 3 because while I was reducing my risks I was also diluting my gains. Having 50 stocks also showed that I was not confident in the research that I was doing.

So in 2013-2014 period I moved to another extreme. And at 1 point held just 3 stocks. While I did make money on them because I had managed to pick them up at cheap valuations and the market rally after Modi’s victory, I would be shit scared before the results of those companies came out.

I could not take that pressure any more.

So I started diversifying. Now my strategy is if I have 100 rs to invest and I am expecting companies A and B to appreciate by similar percentages then I will put 50 rs in both of them.

It has worked out well. My mind is at peace.

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I have experienced these kind of jitters with my concentrated portfolio. Occasionally I ask myself if a company in my portfolio reports a bad quarter and stock drop 10% or more, will I sell it? If the answer is Yes that means my conviction in that company is at a tipping point and I look for a replacement. So far I have managed to avoid jitters that way.

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John Templeton made his first big money by investing in over 100 penny stocks
Three approaches exists

Large scale Diversification like you have done . It works when

  1. General Market condition is bad and is at a point to change for better ( ie valuations are low )
  2. You are not able to estimate which sector ( or which companies ) will do well because of large scale uncertainity

However if you are planning to adopt this approach best way to investing is pick two / max three diversified mutual fund and invest every month .

Second approach extreme concentration : It worked for Bill Gates , Dilip Sanghvi etc because they are in control investors .

Third approach circle of competence investing which most of valupickr guys do . Say you understand one or two sectors because either you work or have done research to understand that sector . Here you can select large cap , Mid cap etc companies and invest regularly . But while following this strategy try to keep good allocation ( > 25% ) in fixed income / debt so that it can take care of contingency expenses and also can be used as cash to buy when sector unexpectedly corrects …

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You can check my portfolio thread. I was in a similar state. Some of advice which I received and has worked for me:

  1. Create a framework for analysis : 1. Qualitative framework scorecard, a checklist, business performance scorecard, valuation scorecard,personal touch, assumptions why you want to stay invested in this stock and why/when/in which scenarios you will exit the stock.

This will help you to cut out some of the stocks

  1. Go through the annual reports, concalls, research reports, market understanding of sector and operating model for the one who successes in step 1. Again, some more will be out of list

The process may take 6 months to 2-3 years based on time, availability, ability and dedication but is a way forward and has helped personally.

Then, for the finally selected stocks

  1. Make a folder for each stocks where all AR, transcripts, analysis is there and read read read
  2. Set a google alert on yoru companies to stay updated
  3. Track them on quarterly/semi-annual/annual basis based on conviction on each stock

From portfolio suggestion, depends on everyone’s style but as I was in your position few montsh back , This is what I have done:

  1. Have created a portfolio of 15-18 stocks where I have conviction (ongoing exercise)
  2. There are few sectors which I still do not understand companies end to end but convinced enough (history, learning from stalwarts) that they will make money, continue with a portfolio approach picking some of good companies till you develop that clarity or else ignore completely.
  3. Keep a ratio of say 80;20 as per your comfort for these solid conviction ideas and exploration ideas. You can have 20-30-40 in exploration ideas not crossing a consolidated threshold and can explore them over a period time and either shift to core (which needs a strong reason to replace one from core else you will be back to square one) or discard from your overall portfolio.
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Thanks Shailesh for your inputs, very helpful.

Thanks Saurabh, informative and will put it to use.

This is important piece of advise. Keep some space for exploratory ideas. Thanks for sharing.

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Hi, just wanted to thank all of you for your suggestions and feedback and give a quick update on the progress I am making. I have been spending some time over the last few weeks reading through the various threads on Investing Basics, and parts of Art of Valuation & Capital Allocation framework links.

I have started pruning my portfolio from 44+ stocks to about 32 stocks on date, and this will be an ongoing exercise. When I joined VP group few weeks back, and I had shared my PF as I felt that I had too diversified a portfolio and was unable to keep track of the companies. I had received very good inputs and recommendations on the approach and I am thankful to the community for the same. I have started pruning my investments and from about 44 in Sep end to about 32 now. This will be an ongoing exercise as I keep learning about investing.

After reading the forum discussions, I was looking at my portfolio and reflecting upon how I wanted to invest in future, I was faced with the following thought processes:

  1. Sell my current stock holdings and sit on cash, learn about new opportunities emerging in the market, completely understand the business and the fundamentals, and if I have a conviction on investing, get into the company.

  2. Research on maybe 1 company every month from my existing portfolio itself, understand the business model completely and if at the end of the month, I have the conviction that it’s good to hold/increase exposure, make a decision and proceed. Else, get out of it and look for opportunities elsewhere.

  3. Use the forthcoming 2017 to completely understand value investing framework, identifying opportunities, understanding business fundamentals, valuation mechanism, capital allocation, identify red flags and value traps etc.
    Basically, i want to develop my knowledge levels from an absolute zero to atleast 40% (this number sticks with me as it’s generally considered a pass mark in exams :grin:

To start off, I have tried to put down whatever I am aware of the companies I hold and I asked myself 2 questions:

a) Can the stock double in the next 3-4 years?
b) Do I have the conviction if my question to above is YES.

However, after I thought about my conviction and knowledge levels, I am 200% sure that this borrowed conviction will be proven wrong. I am still undecided on how should I proceed with my existing portfolio. I shall maybe sleep over it and find an answer.

Any comments and suggestions from VP Forum members are most welcome. Wish you all a very happy, prosperous and knowledgeable New Year 2017.

Best Regards
Varadharajan

hi,
this is my 3rd year into investing and i have about 52 stocks in my portfolio, mainly made up of small cap and midcaps. just 5 - 6 stocks belong to largecaps.

I donot believe in reviewing the company performance every quarter. I review them annually.

I list the pros and cons of such holdings as per my opinion :
Pros -

  1. Allows you gain from ‘everywhere’ and doesnot limit your profits ONLY because your portfolio shouldnt exceed ‘X’ number of stocks.
  2. Diversifies your risk. None of my holdings exceed 7% of my portfolio value. Some are as small as 1% too. If my conviction is low, i start with smaller amounts.

Cons -

  1. A bit difficult to review all the stocks. 50 stocks to be reviewed annually too is quite a daunting task.
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Diversification is the refuge of those who aren’t willing to put in the hard work it takes to run a concentrated portfolio. I might rub some folks the wrong way here but that’s what I believe. I am yet to meet someone who has created wealth through a diversified approach - not just in stocks but building businesses as well. Diversification makes sense for those who have enough wealth so that marginal utility of wealth for them isn’t considerable.

Diversification is usually Diversi"fiction" that gives you a false sense of a semblance of safety

A word of caution on running concentrated portfolios though - be paranoid about valuation when you buy. A low enough buy price usually hedges most risks assuming the qualitative aspects of your research are spot on. 10-15 stocks where you know what you are doing should get the job done for most people.

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There Are 2 lines of thought…

If one is investing in companies that are fairly known, decently tracked, have decent amount of publicly available information, give periodic updates about themselves, are somewhere midway in their journey of growth, have some sort of financial track record etc. then one can take the risk of concentration.

If one is investing in unknown companies, that are not tracked by many, have limited public information, give out only the mandatory updates about themselves (such as quarterly results), who are at the start or just started their journey (or is turning around), then the risk of investing in such companies has to be managed by diversification.

I would be very surprised (and willing to learn) if someone is investing in small/micro caps of the 2nd type above in a concentrated manner.

Both approaches work in their own ways. Its more of one’s preference.

Mutual funds diversify in known names - so its neither the 1st approach, nor the other. Which doesn’t work as well.

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That is because they have no other choice, the market depth outside of the Top 100 names ain’t enough to absorb a large amount of capital.

Mutual funds also suffer from problems of scale and reputation - If a fund manager takes a bet on a company that is not well know and fails, it will do his reputation a great deal of harm. If he bets on a well known company and fails he can turn around and say “I took a bet on a well known brand”, his reputation is intact.

In general what a mutual fund manager buys should not be the benchmark for anyone on this forum, we do not suffer from their constraints and lack of agility. Unless one thinks he can do better than the mutual fund manager at either security selection or portfolio sizing, he’s better off giving his money to the manager and keep off stock picking.

I am sure that if the good mutual fund managers were to be given access to long term capital and given a free hand, most of them would do things differently. The incentives just aren’t in their favour to try too many different things out in their institutional investor avatar.

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Diversification strategy was followed by Top Investors : John Templeton ( 100 stock story to hit his first Million ) , Walter Schloss , John Greenblatt , Ben Graham … etc .

Even Warren Buffett held more than 30 stocks though he keeps telling us to be more concentrated .

One needs to know when diversification works . If quantitative selection has more weights in your stock selection and you don’t have extra qualitative edge in business ( insider kind of info like you are owner / promoter / government regulations etc ) you should diversify .

Diversification strategy was followed by Top Investors : John Templeton ( 100 stock story to hit his first Million ) , Walter Schloss , John Greenblatt , Ben Graham .. etc .

Comparison with biggies managing billions is out of context I feel. Let us focus on retail investors like us who have a relatively much smaller portfolio unless you belong to the big league. I remember Buffett mentioning in one of his speeches that a much higher return(50% compounding) is possible for smaller portfolio(few million $). So Size does matter.

If you have a 3% allocation and even if stock becomes a 5 bagger it just moves your portfolio by 15%. Another stock with a 15% allocation and a similar gain can swing your fortune.

As @zygo23554 mentioned, hard work is needed to get the conviction and then only one can allocate big.

But again it depends on individual to decide how they want to allocate. After all it’s their money.

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There are two points in @zygo23554

  1. "Diversification is refuge of those who not willing to put hard work "

  2. " I am yet to meet someone who created wealth through diversified approach"

These are totally wrong and misleading statements . I have quoted large successful investors who have adopted diversified methods right through their career ( irrespective of size of funds ) . I have personally become financially independent by adopting this strategy .

The key is to understand while diversified strategy works well for most of the value investors ( who follow quantitive measures like PE , P/s , Dividend yields etc ) ,

Concentrated investing works in long term only if you have insider info of firm or industry

Now coming to points like SIze does Matter . Yes it does , but that does not explain why these large investors were diversified investors during their early stage also . Remember even Buffet took concentrated position like in Dempster only when he could control management … or get a board seat otherwise he was as diversified as the rest .

On 3% allocation becoming 5 baggers case --> You have to remember 15% allocation in a stock that loses 50% value can be big HIT to portfolio also . Downside risk protection is a bigger goal for value investors as compared to RETURN.

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This is an old debate and will not die as their are passionate people on both end. :slight_smile:

Personally, I am on the concentrated side. I have also been fortunate to know friends in VP(and TED) who have created great wealth starting from very minuscule amount in last 8-10 years. I have found all of them allocating hugely and believer in concentration.

On a lighter note @zygo23554 's statement is probably true :

  1. " I am yet to meet someone who created wealth through diversified approach"

Most likely he hasn’t yet met any of the people you mentioned.

Anyway, as I said let us follow strategies where we are comfortable and enjoy the process.

Regards,
Raj

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The way I look at Diversification Vs Concentration is that diversification is a risk reduction technique while concentration is a return enhancement technique. If one is comfortable with the risk in the portfolio and want to enhance return then concentration might be the right change to make whereas if one is comfortable with the return expectations of the portfolio and want to reduce risk in the portfolio then diversification may be the right change to make while keeping the overall selection and allocation strategy unchanged.

Both diversification and concentration are relative terms. i.e. if I am holding 25 stocks now then moving to a 15 stock portfolio will be concentration whereas for someone holding 10 stocks, moving to 15 stock portfolio will be diversification.

its well known than benefit of diversification drops with number of stocks. My analysis of my own portfolio shows that return per unit of risk is highest in a 5 stock portfolio with incremental benefit of diversification in reducing risk is very low after 10 stocks. Beyond 20 stocks, I think it begins to hut as investors attention gets divided between too many positions.

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