The Best Investors Never Attempt to Balance Their Portfolios
Most investment advisors would advocate a “diversified portfolio.” Warren Buffet says to “put all your eggs in one basket and watch that basket.” We’re inclined to trust the billionaire’s judgment. A diversified portfolio delivers comfort. But a concentrated portfolio — in the hands of a savvy investor — can produce excellence.
The name Nick Train probably means nothing to you. He runs the Finsbury Growth & Income Trust, a mutual fund that’s posted a total return of 144% over the past five years. How did Train deliver those fancy returns? By running a concentrated portfolio. You see, Train holds only 23 stocks. Most funds invest in hundreds. Train seldom sells a stock. Most funds turn over their entire portfolio in a year’s time.
Most great investors pursue a similar strategy. Warren Buffett is one example that comes to mind, though there is someone who’s done a shade better. (I’ll get to him in a minute.) Warren Buffett probably needs no introduction. He may be the greatest investor who ever lived. If you study his portfolio over the years, a couple of interesting things stand out. The first is the fact that Buffett owns large amounts of relatively few stocks. On average, over the past 30 years, Buffett’s top five holdings made up 76% of his total portfolio. Also, Buffett held onto his stocks for nearly four years, on average. That’s a far cry from the annual flipping most investors do.
Now, what about that guy who did a shade better than Buffett? His name was Claude Shannon. He was a brilliant scientist whose work lies behind computers, the Internet and all digital media. Shannon was also a director for Henry Singleton at Teledyne. I wrote a bit about Singleton and Teledyne in my last letter to you.
Well, Shannon also invested his own money in the stock market. He didn’t start with much money when he first started investing in the 1950s. But what’s amazing is the return he made over time. From the 1950s-1986, Shannon racked up an annual return of 28%. That’s better than Warren Buffett’s. How did he do it?
Some might think that this brilliant man, sometimes compared to Einstein, would’ve been involved in some complex and highflying technologies to get those kinds of returns. Not at all. In fact, Claude Shannon’s approach to investing could hardly be simpler. He was a simple buy-and-hold fundamentalist.
When researchers dug up his investment portfolio, like archeologists poking around for the Holy Grail, they found something that would’ve appalled any modern financial adviser. They found that his three largest positions made up 98% of his portfolio. Nearly 80% of his account was in a single stock, Teledyne. Shannon’s original cost was only 88 cents, after adjusting for splits — a mere penny stock. By 1986, a share of Teledyne was worth $300.
So much for diversification. “We have not,” Shannon once explained, “at anytime in the past 30 years, attempted to balance our portfolio.” Shannon, mind you, was 70 years old at the time and fully invested in stocks. Talk about going against the conventional wisdom!
(An interesting book to read, if you like this sort of thing and want to learn more about Shannon’s story, is William Poundstone’s Fortune’s Formula. Charlie Munger highly recommended it at a recent Berkshire shareholder meeting.)
Now, I know we are not junior “Warren Buffetts.” And we’re not junior Claude Shannons, either. So we should probably not recommend putting 98% of our money in our three favorite stocks. But I want to make the point that great investment returns often come out of portfolios made up of a few stocks held for a long time. And over time, these stocks come to dominate the portfolio.
Really, it gets to one of the key ingredients to successful investing. You should invest only when the odds tilt heavily in your favor. Since these opportunities are naturally rare, you ought to bet big when you find them. If you manage to avoid big losers, you will do well over time.
There are a number of investors out there today who practice this credo. Mark Sellers at Sellers Capital is one of them. I saw him speak about this exact topic at a recent investment conference. In his presentation, he showed the following table. It lists some of the most successful long-term investors in the market today. It also shows what their largest holding is and how much it represents of their portfolio:
A cursory glance shows you how important their top holdings are. At the bottom of the chart is the Vanguard 500 Index, which represents the market. You can see that Exxon Mobil, the largest stock in the Index, makes up only 3.9% of the total. By contrast, all of the top positions of these investors make up a much bigger percentage of their portfolios.
I’ve taken this lesson to heart in my own investing. As of this writing, the largest position in my account makes up 31% of the total. It’s always been a big position, and it’s gone up a lot. I refuse to sell it — so naturally, it’s come to represent an ever bigger chunk of my portfolio. In fact, it’s never been bigger. (Again, I’m not recommending you do this.)
You have to have a lot of conviction about an idea to bet that big. But you don’t have to go whole-hog to apply the basic lesson to some degree in your own investing. Instead of owning 50 or 100 stocks… try to pare that list down to the best ideas. Instead of investing in mutual funds that own hundreds of stocks and turn them over every year, try to find those that own fewer stocks and hold them longer.
The Wall Street Journal recently ran a screen of these kinds of funds. I’ve pasted the table below for your convenience. It’s not a bad list to start research of your own. All of these funds carry no loads, have 50 or fewer stocks and are run by managers that have been there for at least five years. Each of them also has, not surprisingly, a track record better than those of 75% of its peers:
A word of caution: Focus means that your portfolio becomes more volatile. For the great investors, this is no concern. They take on that price volatility in the short term if it means better returns over the long haul.
Take Nick Train, whom I mentioned above. His fund was actually down as of late 2007. So does that mean he gives up on these ideas? Of course not. “I don’t really care that much about performance relative to the market over the next six months. I don’t want to sound blasé or [say] that it doesn’t hurt, but the only thing we could do about it would be to dismantle a set of investment principles we have had in place for some time and that have done well by our investors.”
I couldn’t agree more with Train…or with Buffet. Invest selectively…and “watch the basket.”
February 21, 2008
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