I think this has been a tough period for what is often called high beta stocks/funds. These are ones that move up by more than the market when it is going up and vice-versa.
A few random observations which may be wrong they are just food for thought:
- May people dismiss diversification, even investment gurus like Munger/Buffett. But diversification is insurance against being wrong. It is certainly possible to be wrong. I am a bit wary of having more than 10% in an individual company.
UCITS fund rules are 5/10/40 rules are to ensure that regulated funds stay sufficiently diversified e.g. Fundsmith. No more than 10% can be in one stock and the sum of stocks worth more than 5% can not be more than 40% of a portfolio.
Let us say we follow some aggressive investors and have 50% of a portfolio in three stocks we will be massively hit if they all go wrong. It can also be useful to be diversified by different company types.
- Position-sizing - This area tends to generate a lot of debate. Most new investors position-size according to the potential upside. And many investment gurus encourage this. It sounds great in theory? Our best ideas should be the largest position sizes.
The problem is that it leads to people betting the most on the riskiest stocks because these are the ones with the most potential upside. But they also have the most downside.
Risk should be the top priority for a portfolio. The very point of a portfolio is to mitigate risk otherwise we would just bet on one stock. It follows then that we should position size according to risk.
This means that the largest positions should be lower risk and smaller positions can be higher risk. The alternative approach of having high risk stocks as top positions creates significant portfolio downside risk.
I have personally got wrong position sizing according to upside rather than risk. Risk is much easier to focus on. When I look at funds I want the top positions to be sound companies as opposed to unproven companies. This is one reason I have not been so keen on Baillie Gifford-run funds.
- How much volatility can you take?
The same investment styles tend to move together. We have seen that this year. Growth/quality have sold off a lot. If you only own those you will have suffered from significant volatility. Many of us can take volatility in theory but not in practice.
Some portfolios are 20% bonds and 80% stocks to reduce volatility. If the stock market goes down 50% this portfolio would only be down 40%, which can be easier to stomach. It would be rebalanced over time to keep bonds at 20% and so if markets fall the bond part would be reduced to buy equities.
So it has fallen 50% and is now worth 60 and the bond part would be worth a third of the total. It would be reduced by selling 8 in bonds and using that to buy equities. Similarly, we rebalance away from equities if markets rally.
This actually has the potential to improve returns if we see lots of bull and bear markets because it sells stocks during the bull run and buys during a bear market.
We should be honest with ourselves about how much downside volatility we can take. There is no point having a 100% equity portfolio if you panic sell near the bottom. Nothing wrong with having a % in lower risk assets to provide a smoother ride.
Stocks like Amazon have been massive winners but have had huge drawdowns along the way. Can you take the pain? Not sure I would have been able to do so. I am not great at handling drawdowns and so I try to reflect that in what I do.
Some people went 100% into cash during the Covid sell-off in March 2000. They would have been better off having say 30% in bonds and 70% in equities and then their portfolios would have been less volatile.
- Have some part of a portfolio in something that will hold up.
Maynard’s portfolio has cash as a large position. But it could be a sound passive fund in lower risk stocks like consumer staples. In my view, this is useful to keep to hand for reassurance and as dry powder. It could be just 1% of a portfolio or 0.5%. Or you can rebalance towards it if markets are strong.
Let us say stock markets are very strong you could slowly increase the cash position. I wouldn’t really call this market timing it is more a case of rebalancing away from risk assets while they are doing well in the same way the 20% bonds and 80% equities example did previously.
- potentially rebalance away from stocks that have done well.
Small cap stocks are volatile and can go wrong. If one has gone up a lot it makes sense in my view to rebalance a bit. A lot of people seemed to hold Best of the Best as it went up believing it would be the next big thing. But in my view, it would have made sense to say take 50% off the table over time.
Mark Slater does reduce stocks that have done very well to reduce his risk exposure to them.
- Stress test your portfolio
What if your top 5 positions went wrong. Could you survive that? It is unlikely that all 5 would below up but what if they did?
Cake Box -
Cake box - I used to have a big position in this and was optimistic about the company. But I realised I didn’t really have time to monitor it and so exited and replaced it with funds. This was a bit gutting as the share price kept on going up after I sold.
But my rationale for exiting is that to really protect my investment I would have to read all the annual reports, announcements and do competitive due diligence etc. At the moment I don’t have time to do that.
Cake Box now appears to have some accounting issues as highlighted by Maynard and so thank heavens that I sold.