It did not take me long to start assigning allocation weights for Portfolio construction. I was ready to create a Concentrated Portfolio for myself!
A word of caution as we proceed: This exercise is probably relevant for people who can devote full-time, or a major part of their, energies into actively Investing in Markets. Passive Investors (with full-time jobs) are better off with a well-diversified Portfolio. But even they would benefit from being able to differentiate among their bets!
Why a concentrated Portfolio for myself? As I looked back over my last 3 years or more or less pretty active Investing, I have a natural bent to go deep, to understand the stock story as best as I can, I put in much more effort into stock selection than most people do or need to:) Many folks like Hitesh get it 80% right with 20% of the effort I tend to put in:). I don't have that gift...but hey I like knowing in & out of the company I am invested in!But have I made the most of my real hard work? The answer is NO!
So I offered back this model to Mr D, and asked for his comments.
|
Undervalued |
Conviction |
Max Weights |
Allocation |
Portfolio |
|
|
High |
vs |
High |
40% |
Highest allocation |
long-term |
|
High |
vs |
Medium |
20% |
Normal allocation |
short-term (long-term as conviction builds) |
|
Medium |
vs |
High |
20% |
Normal allocation |
long-term |
|
Medium |
vs |
Medium |
5% |
Nibbling allocation |
short-term (long-term as conviction builds) |
|
Screaming |
vs |
Highest |
Call addl. funds |
Can override guidelines |
long-term |
He said "You got it!".
Allocation Limits
I asked him isn't 40% like way too high/risky. He smiled "Why not? Remember, it is your stock - you know it in and out, its pretty individual, you know that - your personal situation and risk taking ability decides. Even a 25% max allocation may be too much for most folks. But I would think everyone needs to think on these lines and differentiate among their best picks. Which is No#1, and why? and why is that one No#5? Can you explain that lucidly to a layman in 2-3 paras - A framework like this forces you to think that way, that's the idea"!
Liquidity Impact
I asked him "What about illiquid stocks with low average trading volumes? Our kind of stocks have an impact cost in entry and exit." He said "In my experience, stocks with strong fundamentals, good growth and low liquidity has actually worked to my advantage, most times! Low liquidity shouldn't matter, if you are invested for the long term. That reminds me, your Portfolio must always have the strength to encash on big drops in your high conviction stocks, say when the whole market tanks. As a rule, I like to remain 20% CASH, atleast. In times like now I like to be 40-50% cash. Work out yours"!