a catalogue of errors, page-10

This was a comment on an InvestSMART discussion page I’ve copied but I think it is relevant here and also to a discussion a few of us incl @madamswer @travelightor @mal85 @andy777 @MarsC  were having about portfolio concentration on the Sdi thread a few months ago. Just thought I’d share as I thought it was an interesting perspective.

‘In my view there continues to be an unhealthy degree of preference in the industry for highly concentrated portfolios.

In truth, the outcome of any individual stock call is partly dependent on luck and partly dependent on skill. Consequently, the fewer stocks held in an investors portfolio, the more likely it is that the performance outcome was driven by chance rather than skill, so it is hard to assess the capabilities of the manager.

This is why we have seen many previously high-performing managers like Einhorn and Ackman subsequently blow up. A large part of their prior celebrated success came from holding concentrated bets where chance played a significant role in the outcome. If they had held more diverse portfolios they would have been less able to rely on luck the generate marketable track records.

It is much more impressive when someone delivers strong returns with a broad number of holdings, because it indicates that the investor has a repeatable process and that the returns they are generating are most likely a function of skill rather than chance. The greatest investor of all time, in my submission - Peter Lynch - held more than a 1,000 stocks at many points in his career, and yet still delivered great returns.

Great investors are able to identify opportunity in a large number of stocks so they don't need to be concentrated or rely on luck to generate good returns. The gains may not be as spectacular in any one given year as the concentrated players, but the risk of blow up is much less.

If i were looking for a manager, I would look for someone with a track record driven by a repeatable process that did not rely on one or two outsized winners to generate.’