In our view, taking money out of your best ideas where you have the most confidence in future returns and ability to withstand risks to put it in companies you know less about and have less confidence in makes little sense.
Phillip Fisher who has one of the best long- term track records said it this way many years ago:
“Investors have been so oversold on diversification that only a small percentage of their holdings are in attractive stocks that they know much about. It never seems to occur to them that buying a company without having sufficient knowledge may be even more dangerous than having inadequate diversification.”
We have found that for the equity portion of portfolios 15-25 well selected companies provides adequate diversification and that our knowledge level of companies in the portfolio is greatly diminished with more than 25 holdings. That knowledge deficit along with allocating money away from our best ideas makes it more difficult for us to produce attractive long term returns in a risk averse way
Further, we believe investors underestimate the differentiation in returns and valuations in the companies comprising the market. To us, this variation means there is an opportunity for concentrated portfolios to avoid the more overvalued and or overleveraged sectors of the market but only if rigorous hurdles are met and you are disciplined about implementing your investment process.
Phillip Fisher who we mentioned earlier did a five study many years which is outlined below of 140 companies in the various Dow Index’s at the time that started with an A or T. He found a wide variation in returns over the period among the 140 companies. (Common Stocks and Uncommon Profits first published in 1958)
Opportunity Cost of Diversification
Emma Dill - Nov 27, 2023
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