2021 Review: What's with the name?
Fighting the demon in me or am I tilting at windmills?
An oxymoron investment concept.
I have touched on this quite a bit in my past and the reason is that I am always oscillating between diversification and concentration.
The usual narrative plays out like this.
STEP 1: I start by finding lots of undervalued names in a sector (geographical, industry) which had gone down in price. I started going through those names and soon is averaging 1 new name and 1 new investment every other week. After half a year, I have a zoo like portfolio, companies of all shapes and sizes. I have a hard time handling the demands of this zoo and soon I am culling names off my portfolio.
STEP 2: With the capital released from shackle, I will deploy them into existing position which had shown the highest business traction or capital gain. These companies had been “validated”. The diversification to concentration journey would have started and the portfolio got trimmed down to a good manageable size. Then, the narrative shifts again.
STEP 3: Seeing that one or a few stocks is having an outsized movement on my portfolio, I will then decide to shift some of my gains into smaller position to help diversify the holdings. That usually meant dwelling into new sectors and discovering new and interesting companies which I have never seen before. Valuation metrics were developed and then it is STEP 1 again.
Sometimes I get the cycle wrong. I may decide to go into concentration just before a market crash or I may be too diversified going into a recovery thus not participating fully in the upswing.
All these are vagaries are things I am keen to put behind me.
That meant that there is a need to create a system to handle the demons within me.
The way for me to manage this cyclical changes in my psychology is to divvy up the portfolio into various parts (Special, Super, Sustainable, Statistical) allowing myself to manage the portfolio.
There is inherently nothing good or bad with concentration or diversification. There are adequate argument for either. The aim is to dance between the two and achieve outperformance while allowing for sufficient diversification by
allowing for cross industry-geographic insights
widening of circle of competence
building optionality-resilience to the portfolio
This often reminded of the football scene in Europe where there are tiers of lower ranked football club trying to get into the higher tier competition looking like a pyramid.
The great difference with soccer in the USA and Major League Soccer, however, is the system of promotion and relegation.
In Europe, teams move between levels of the pyramid at the end of each season. That means a set number of clubs at the bottom end of a division (except in the bottom-most league) will drop into the one below. Sides finishing at the top end of all leagues – bar the top tier – will move up a level.
The structure of European football help create a robust talent building and fan building system. Each reinforce the other.
The philosophy on portfolio construction should help create a robust and resilient portfolio. Each should reinforce the other.
Named Weighted as the portfolio hope to achieve high probabilistic positive expected returns through weighting each position. While picking the right company is important, portfolio construction is the key here.
“It's not whether you're right or wrong, but how much money you make when you're right and how much you lose when you're wrong.”
It could be
better operating numbers
better environment for growth
or simply that the competitors are screwing up…
The idea is to weigh heavily into a position when there are new information telling you that it is working.
By maintaining, sufficient breath and depth in the portfolio, there is a chance to increase or decrease the weighting of each position according to how the story plays out.
The way to understand this portfolio construction is that I am aiming to construct a portfolio that is diversified across
Different geographic region
Different Industry sectors
Different Investment baskets
Different time period
Different geographic region:
The portfolio primary market used to be in Hong Kong, Singapore, Malaysia and Australian. In the past few years, knowledge had been build on companies-industries in North America (US and Canada) and UK.
The initial results seems encouraging as pessimism in one market usually is offset by optimism in another helping to balance returns. The ability to diversify across markets also allow the portfolio to dynamically weight the position in each of the market.
Every country has its own individual quirks and building that gut feel and understanding on a market usually takes an awful long time. The model of just buying cheap stocks simply does not work in many countries.
Weighting allows me to dynamically shift my position allocation by balancing the risk-reward return offered by the various geographic region expressed through the different industry sector.
Different Industry sectors:
Staying within the circle of competence is something everyone talks about.
But expanding that circle of competence is something to be frown upon?
While the search for permanence is critical, there is a need to understand that every business-industry-theory is bound to be ‘invalidated’. That meant that there is a continuous need to expand the circle of competence. Moving into adjacent industry and completely new one will be the key to that.
Weighting allows me to continue to invest in industries which one may not be familiar with allowing knowledge to be build up forming into various investment baskets.
Different Investment baskets:
The ability to traverse between value (statistical), growth (super), event-driven (special situation) and long term (sustainable) meant that the portfolio is ‘immune’ to changes in preference of style in the market.
There is times when there is more uncertainty in the market and value (statistical) seems like the way to go.
Or when growth (super) is price like value and growth is obviously the better option to have.
Or when there are sufficient event-driven (special situation) to take advantage of.
Or when there are long term (sustainable) companies with the pedigree being sold at fair value allowing one to compound comfortably for many years.
By building a multi-investment basket portfolio across different industries and geographic regions, one is able to consistently invest across different time period.
Different time period - Buying:
Taking a single big stake over a short period of time is what I use to do in the past.
Now, I like to build my position over time.
Instead of believing in my skill of picking companies, I can now see a pattern of ‘luck’ in place.
The only complain is that the aim to work humility into my psyche has been working too well.
The main difference now is that I have learnt to embrace my ‘luck’.
The main important point is to understand that you have been lucky to enter a good position and be able to weigh heavily when ‘luck’ is in your favour. That means that sizing into a position is as important as the initial decision of buying.
By building a position through time, the overall expected return will tend towards positive as one is averaging down when there is maximum pessimism and averaging up when ‘lady luck’ is shining.
Investment maturities - Selling:
While everyone tends to want to hold forever (including the lazy me), there is an expiration date for most things (including the universe) and it could be said for industries-companies-theories as well.
The aim here is to ensure that there is various maturities within the portfolio. Turnover of portfolio is usually frown upon but if the reason is the expiry of a theory, then it sounds like reasonable explanation.
By building a portfolio of companies with various time maturities meant that there is always some new cash coming right into the portfolio allowing a manager to deploy into new areas allowing for sufficient recycling of capital.
Selling tends to be swift as maturities happen when a theory is invalidated or when the theory had matured allowing capital to be recycled into position across different geographical regions, industries and investment buckets across time periods.