Wealth Generation and Portfolio Concentration
One of the key differences touted by PMS fund managers are the fact that they are long term oriented and willing to take higher risks by having a concentrated portfolio.Historically there have been examples of great fund managers coming off with huge returns when they bet and won big.
But history is written by the victors and we never know the number of investors who bought and held concentrated positions only to see large portions of their capital being wiped out. Survivor Bias is a key logical error one has to be aware of.
Rakesh Jhunjuwala is a man of many traits when it comes to the stock markets, but much of his fame comes from an investment he made way back in 2002 – an investment which today contributes to a third of his networth.
In the world of investing, its sexy to talk about big risks that paid off. Soros shorting the Pound is part of folklore history now, but it’s interesting to note that despite the fund being highly leveraged, they had a lot more positions other than the short on the pound. But it was not a risk that was foolish.
Steven Drobny in his interview with Scott Bessent in the book “Inside the House of Money” talks about that trade. The position was Gigantic, but that did not mean that Soros who asked Druckenmiller to go big risked the future of his firm on this one trade. Quoting from the book,
“With the pound, we realized that we could push the Bank of England up against the trading band where they had to buy an unlimited amount of pounds from us.The plan was to trade the fund’s profits and leverage up at the band’s boundary.The fund was up about 12 percent for the year at the time, so we levered the trade up to the point where if they pushed us back up against the other side of the trading band,we would lose the year’s P&L but not more.”
Inside the House of Money by Steven Drobny
In other words, the worst that could have happened if they went wrong was going back to square one for the year. But if right, they were likely to make a Billion which they did.
Once in a way, a big investor bets the farm and comes out as a winner with the biggest example being when Warren Buffett bet big on the stock, putting 40% of his partnership’s assets in American Express shares. But such instances are rare and even then one off.
Let’s go back to Rakesh and his stake in Titan. In around 2 quarters of 2002, he accumulated a 4% position in the company spending approximately 12 Crores. 12 Crores is a very large sum and betting that amount of money on a single stock may seem as recklessness but Rakesh hasn’t accumulated his wealth by being reckless.
In an interview Economic Times, he puts his networth in 2002 at around 250 Crores. 12 Crores when seen from that perspective was around 2.5% bet (in fact since he was levered, overall size of the bet would be even small). But that bet worked wonders to the extent that today constitutes approximately 40% of his networth.
Titan in 2002 wasn’t a dazzling stock. In fact, from 1995 when it started trading on the National Stock Exchange, it had gone down by more than 50% with another watch maker, Timex doing even worse by being down 77%. Nifty on the other hand was flat post the crash following the dot com burst.
The outcome of one stock dominating to such an extent in one’s portfolio isn’t a random occurrence either. Take the story of Anne Scheiber who is considered one of the great equity investors of the 20th century. Once again, wealth was not accumulated by a small number of concentrated positions but basically buying and holding a large number of stocks for lifetime.
While its guaranteed that quite a few stocks will be worthless, the overall portfolio can be a big gainer since the upside for stocks can be infinity versus just losing the capital if it goes bad. Recently there was this article about Voya Corporate Leaders Trust that hasn’t traded for 84 years and yet has beaten the S&P 500 over its lifetime.
More than 5 years back, I had written a post titled Throwing Spaghetti Against The Wall. My testing that over the long term, even a randomly chosen portfolio of stocks had a very high probability of beating the benchmark index.
Of course, this doesn’t mean that one should randomly invest into stocks. What it shows instead is what one remembers from one of the famous paragraphs from one of the greatest story ever told – Reminiscences of a Stock Operator.
In fact, if you were to think about it, the reason Coffee Can strategy works is simply because you are filtering for good quality stocks and then holding them for a decade. Not every stock will yield great returns, but the overall outcome is far better given that the selection is not random but consists of a well thought and tested strategy.
In 2016, after reading Saurabh Mukherjee’s book The Unusual Billionaires, I had invested in one such set of stocks for my brother.
It recently completed 3 years in which I haven’t done any trade. As on date, the portfolio is up 53% slightly beating the Nifty 100 which was the benchmark I am using. This despite the fact that 5 out of the 16 stocks that I have invested are in negative territory.
There was this interesting thread and one of the tweets applies when we look at investing in markets.
As investors, we are just side-car passengers. We are in a way at the mercy of the promoter and his idea. If it works out well, we claim credit for identifying it at an early stage while if it fails, it’s easy to blame the promoter for the various acts of omission and commission.
When I tested for my Momentum Strategy, the outcome was that the most optimal position size was around 25 stocks. But I have chosen 30 since it reduces the risk even further while allowing me to stay in stocks that have intra month dips without the need for panic.
Then again, my strategy is hole and sole based on the price of the stocks and nothing to do with fundamentals. But even when you know the company better than even the promoters, there is no telling what you may be missing and come back to bite. Should you take that Risk when your future is tied up with how well your investments will do over time?
While I can try and optimize it even further to gain those few extra bips, I have come to the conclusion that I can do better by just allocating right. A tactical Asset Allocation combined with a philosophy that works over time is good enough for me.
Investors take all kinds of Risks to earn a couple of percentage extra when even a small allocation to equity could have given them the same or even better return with much less headache. Then again, where is the thrill in it. Same is the story with Concentrated Portfolios.
Hi Prashant, Can you write a blog on tactical asset allocation?