I appreciate this reasoning and your conclusion that there is room for both concentration and diversification in a portfolio. I agree with that conclusion and I think a portfolio with some large, fairly concentrated positions backed up by what I think of as a "long tail" of small positions makes a lot of sense and has many advantages, especially for those of us who invest in small companies and microcaps. I also think there is something to be said for allowing a portfolio to naturally concentrate itself.
I think position sizing is more important as the portfolio changing versus positioning sizing while establishing positions. I just wonder if too much position sizing decisions could actually hurt returns. For example, the MSMqi is assumed to be a diversified portfolio with the same amount of money invested across all the stocks. It’s now at about a CAGR of 30% over 3 years. However, maybe it would’ve been much better with positioning sizing with deeper due diligence in some of the stocks that are delivering on their growth goals, assessed on a quarterly basis.
100% agree. Also , when initiating a position, I tend to have a blend of buckets. First bucket - I just want to have exposure. Second bucket - I like it but don’t love it just yet. third bucket - I love it … that’s where I’ll go big. But to be honest with you, I’ve made most of my money in buckets one and two that eventually become a high portfolio weight because they’ve just gone up and delivered.
The reason for that may because that they are in buckets one and two due to the extra risk or uncertainties that, in hindsight, makes a company very cheap. Basically, the unraveling of the risk premium unlocks a lot of upside that wasn’t being priced in.
That system sounds really good and I'll probably need to adopt a version of it. I can totally imagine lots of return coming from the first two buckets. The longer I do this, the more I think "position sizing is the answer" to lots and lots of investing questions and situations.
Hi Jon, I couldn’t have said it better than you just put it, especially what you said:
“ I also think there is something to be said for allowing a portfolio to naturally concentrate itself.”
It’s also a thought in the journal entry that I’m working on. Just let the great companies make their way to become the biggest positions. If you’re a good stock picker, that’s going to happen naturally for over 40% to 50% of your positions, maybe even 70%. The math just works in your favor at that point.
The bigger challenge as I see it is how do you manage your portfolio, as the best companies rise and become a bigger weighting in the portfolio and how do you adjust those position sizes? In the past, I have let some of my positions get to get to about 30 40, 50%. Needless to say, I had some sleepless nights.🤣
That's a very fair point, and I hope it's a situation I encounter soon ;) I think managing positions like that would largely be determined by an investor's individual life circumstances and investing goals (or maybe mandates). Perhaps for anyone, those large positions could at least serve as a really good hurdle rate for new positions, since new positions would likely be funded by selling portions of the largest positions.
Hi Jon, I’ve thought about the hurdle rate line of thought. One thing I’ve experienced when hunting in a high-quality or high multibagger hit rate potential pool stocks is that I don’t want to overthink things too much. Our microcap quality index has also strengthened this observation. So, when it comes to looking at two stocks to buy or bringing a stock into the portfolio by eliminating another one, I increasingly approach the decision with the frame of mind of positioning sizing as opposed to mutually exclusive decisions. I kind of want to limit the amount of difficult decisions I have to make if I think my process is good. It’s like that old saying, if it ain’t broke, don’t fix it. Really, I’m thinking… do I like the stocks or do I not like the stocks and do I think they have multibagger potential … over what timeframe? I think you’re saying the same thing in part of what you wrote, but from a concentrated position point of view.
Absolutely, I'm glad you brought this up - I think my using the term hurdle rate probably gives the impression of wanting to weed out as many new ideas as possible. But really I think the threshold for initiating new positions should be low. Like you said, not overthinking these small new positions, and using position sizing as the answer to gaining the multibagger potential in the portfolio while still managing the risk of new positions that we're not as familiar with. I think where the idea of a hurdle rate really comes into play is: if you want to go from having a small position in a name to having a large position in that name, it needs to essentially "fight" its way up the existing order - either doing so by naturally becoming a larger weight in the portfolio due to its own success as a company/stock, or by being a compelling enough opportunity that we would choose to allocate more to it instead of other things in the portfolio.
I appreciate this reasoning and your conclusion that there is room for both concentration and diversification in a portfolio. I agree with that conclusion and I think a portfolio with some large, fairly concentrated positions backed up by what I think of as a "long tail" of small positions makes a lot of sense and has many advantages, especially for those of us who invest in small companies and microcaps. I also think there is something to be said for allowing a portfolio to naturally concentrate itself.
I think position sizing is more important as the portfolio changing versus positioning sizing while establishing positions. I just wonder if too much position sizing decisions could actually hurt returns. For example, the MSMqi is assumed to be a diversified portfolio with the same amount of money invested across all the stocks. It’s now at about a CAGR of 30% over 3 years. However, maybe it would’ve been much better with positioning sizing with deeper due diligence in some of the stocks that are delivering on their growth goals, assessed on a quarterly basis.
100% agree. Also , when initiating a position, I tend to have a blend of buckets. First bucket - I just want to have exposure. Second bucket - I like it but don’t love it just yet. third bucket - I love it … that’s where I’ll go big. But to be honest with you, I’ve made most of my money in buckets one and two that eventually become a high portfolio weight because they’ve just gone up and delivered.
The reason for that may because that they are in buckets one and two due to the extra risk or uncertainties that, in hindsight, makes a company very cheap. Basically, the unraveling of the risk premium unlocks a lot of upside that wasn’t being priced in.
That system sounds really good and I'll probably need to adopt a version of it. I can totally imagine lots of return coming from the first two buckets. The longer I do this, the more I think "position sizing is the answer" to lots and lots of investing questions and situations.
Hi Jon, I couldn’t have said it better than you just put it, especially what you said:
“ I also think there is something to be said for allowing a portfolio to naturally concentrate itself.”
It’s also a thought in the journal entry that I’m working on. Just let the great companies make their way to become the biggest positions. If you’re a good stock picker, that’s going to happen naturally for over 40% to 50% of your positions, maybe even 70%. The math just works in your favor at that point.
The bigger challenge as I see it is how do you manage your portfolio, as the best companies rise and become a bigger weighting in the portfolio and how do you adjust those position sizes? In the past, I have let some of my positions get to get to about 30 40, 50%. Needless to say, I had some sleepless nights.🤣
That's a very fair point, and I hope it's a situation I encounter soon ;) I think managing positions like that would largely be determined by an investor's individual life circumstances and investing goals (or maybe mandates). Perhaps for anyone, those large positions could at least serve as a really good hurdle rate for new positions, since new positions would likely be funded by selling portions of the largest positions.
Hi Jon, I’ve thought about the hurdle rate line of thought. One thing I’ve experienced when hunting in a high-quality or high multibagger hit rate potential pool stocks is that I don’t want to overthink things too much. Our microcap quality index has also strengthened this observation. So, when it comes to looking at two stocks to buy or bringing a stock into the portfolio by eliminating another one, I increasingly approach the decision with the frame of mind of positioning sizing as opposed to mutually exclusive decisions. I kind of want to limit the amount of difficult decisions I have to make if I think my process is good. It’s like that old saying, if it ain’t broke, don’t fix it. Really, I’m thinking… do I like the stocks or do I not like the stocks and do I think they have multibagger potential … over what timeframe? I think you’re saying the same thing in part of what you wrote, but from a concentrated position point of view.
Absolutely, I'm glad you brought this up - I think my using the term hurdle rate probably gives the impression of wanting to weed out as many new ideas as possible. But really I think the threshold for initiating new positions should be low. Like you said, not overthinking these small new positions, and using position sizing as the answer to gaining the multibagger potential in the portfolio while still managing the risk of new positions that we're not as familiar with. I think where the idea of a hurdle rate really comes into play is: if you want to go from having a small position in a name to having a large position in that name, it needs to essentially "fight" its way up the existing order - either doing so by naturally becoming a larger weight in the portfolio due to its own success as a company/stock, or by being a compelling enough opportunity that we would choose to allocate more to it instead of other things in the portfolio.
I’d rather have sleepless nights and make a lot of money than sleep well.
A little Ambien and good to go !
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