My portfolio composition to date has been quite simple.

It consists of 25 to 30 positions, all more or less equally sized accept for cases where I bought more at a lower price.

In spite of studies showing that 15 positions eliminate 80% of company specific risk in a portfolio I arbitrarily chose 25 to 30 positions as I knew my selections were not perfect and I wanted a bit more diversification.

I hardly ever have more than 30 positions in my portfolio, as that is the maximum number of companies I can comfortably keep track of.

When doing research for this article I remembered a very good presentation Zeke Ashton of Centaur Capital Partners gave on portfolio composition and concentration at the Value Investing Congress in May 2007.

Zeke graciously agreed to let me use his presentation for this article.

The table below shows the composition of the portfolios of noted value mutual fund managers:

Source:www.morningstar.com as at 10 Aug 09

As can be seen the portfolio concentration differs but they are all relatively concentrated with high percentage bets, up to 22.5%, in one company.

This differs substantially from the 100 plus securities in most mutual funds.

Common Value Investor Portfolio Models

The following are several common “portfolio models” used by successful value investors:

Ultra-Concentrated Portfolio Model

Definition

Fewer than 10 stocks with large position sizes routinely comprising 20-25% of portfolio assets and larger.

Practitioners

Chieftain, Eddie Lampert, Tom Brown

The 10 Stock Model

Definition

Standard position size of around 10%, though there may be one or two larger positions, and a handful of smaller positions for a total of 12-20 ideas.

Practitioners

Clipper, Mohnish Pabrai until the end of 2008, he now uses the 20 stock model below

Standard 20-Stock Model

Definition

Standard position size for a good idea is about 5%, though best 2-3 ideas may be modestly larger and many ideas are somewhat smaller. Total portfolio of 25-40 ideas.

Practitioners

Many of the value mutual fund managers in the above table: Robert Hagstrom, Bill Miller, Wally Weitz, Longleaf Partner, Tweedy Brown Value, etc.

20-Stock Model (Super-sized)

Definition

Essentially the same as standard 20-stock model, but two or three best ideas are “super-sized” to 10-15% of the portfolio, and there are fewer sub-5% positions. Total of 20-30 ideas.

Practitioners

Tilson Focus, Fairholme, Sequoia, Oakmark Select

The Centaur Capital Partners Portfolio Model

LONG POSITIONS

SHORT POSITIONS

The Reliability Pay-off

• Portfolio structure is not about reducing volatility, it’s about increasing reliability.

• You want enough ideas to ensure that your sample size is big enough to reward skill and absorb the occasional bad outcomes, bad decisions, bad timing, or bad luck.

• Adding in a mix of five to ten short ideas further improves reliability.

Maxims Regarding Position Size

• The goal for all investors should be to get the most value out of your best ideas without risking significant capital loss if you are wrong.

• Concentration isn’t a constant - it is idea and environment dependent.

• Your philosophy on selling will determine to some extent how many positions you hold at any one time.

• The more concentrated you are, the more rigorous you have to be and the more good ideas you have to reject.

• The more ideas you have, the harder you have to work.

• Diversification in terms of the valuation factors (Price/earnings or Price/book) also known as Factor diversification can be a good thing as it further diversifies your risk.

• Sample sizes matter. A certain minimum number of ideas is required to protect skilful investors from the capriciousness of luck and unexpected bad outcomes.

• If you can’t sleep well at night, either you don’t own the right stocks or you are running too concentrated a portfolio.

Practical Questions to Ask Yourself

• What type of portfolio is consistent with your portfolio and personal risk / stress tolerance?

  • Can you sleep at night if you have -10% months? or 25-30% peak-to-trough declines?

• What are your goals?

  • Maximum returns (with the assumption of significant volatility) or satisfactory returns within a certain risk profile?

• How many ideas can you process and maintain?

• What kind of ideas do you prefer?

• How stable is your capital base?

  • Are your investors prepared for significant volatility?

  • Do you have safeguards in place to protect your capital from fleeing at the worst possible time?

• Do you work best alone or do you prefer a team environment?

  • A team is going to generate more ideas than a solo practitioner.

Final Thoughts

“Confronted with the challenge to distil the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.”

Benjamin Graham, Intelligent Investor

Why is having a margin of safety important?

• Valuation is an imprecise art

• The future is inherently unpredictable

• Having a margin of safety provides protection against bad luck, bad timing, or error in judgement.

• We believe that the principle of “margin of safety”is just as applicable to portfolio construction as it is to individual investment selection.

The positions in my portfolio has all, more or less, had the same weighting. Zeke's article has however changed my view.

Thinking back there was definitely a few companies that deserved a larger position due to their undervaluation and business quality.

I am however still comfortable with my 25 position portfolio as, in spite of by best efforts and thorough analysis, I was still wrong on a few companies. This was in spite of what I thought was a high probability winner.

I will elaborate on this experience in a future article about my worse investment mistakes and what you can learn from them.  

As Zeke mentions above, valuation is an imprecise art and the future is unpredictable.

{loadposition freesignupbox

P.S.   A company the market forgot about

Last month while running my stock screeners to find attractively valued companies I stumbled onto something that will interest you.

As you know I look for the absolute cheapest companies in Europe, the UK and the USA, irrespective of size and market they are trading on.

This time however I discovered “a gem lying in plain sight”.

It’s a really large company (that you can buy nearly anywhere) that has gotten really cheap. But is so large and obvious that it is completely overlooked by the market.

Something like a diamond lying on the sidewalk, you do not believe that it is a diamond and thus ignore it as you walk by.

Another reason I like the company it that it recently got rid of quite a large millstone around its neck, another factor that should help it perform better in future.

I immediately analysed the company and recommended it to my subscribers.


To find out how you can also get ideas like this monthly click here.