The Concentrated PortfolioSome of the brightest minds in investment agree on the notion of a concentrated portfolio. In 1934, John Maynard Keynes wrote the following famous passage in a letter to a friend: 'As time goes on, I get more and more convinced that the right method of investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think one limits one's risk by spreading too much between enterprises about which one knows little and has no reason for speacial confidence.' Not only was Keynes one of history's foremost economists whose theories have had a major impact on the global economy, but he was also a confident and successful private investor. In fact, the fund he ran for himself, friends and family could be described as the first hedge fund , such were his strategies and techniques. In short, this is the theory of the concentrated portfolio. Why have holdings in 50 stocks to lower risk and diversify when as an investor, you really only believe in a handful of those companies? It is a theory to which Warren Buffett also subscribes. He believes that concentration will actually reduce risks. This is due to the extra care and attention we pay to an investment if we are to invest a relatively large part of our portfolio. Our comfort level needs to be higher and to do this, we need to conduct more research, due diligence and gain a greater understanding. If after all this we still invest, we were at least very well prepared. It is a mystery to Buffett why an investor would choose a twentieth or thirtieth company for investment rather than adding more money to the number one holding. Despite the huge funds that have been under the control of Warren Buffett for many years, he still operates on this theory. His real problem now is that there are fewer and fewer companies in which he can invest that are large enough to make an impact on his portfolio should results be favourable. Most investors are aware that they do not have the skills or knowledge of a Keynes or Buffett and so, for obvious reasons, lack some of the confidence required to operate a concentrated portfolio. All of this seems to be quite contrary to the way in which most money (and most of our money) is managed. An average 'general' pension fund will have hundreds of holdings, some will even have more than one thousand! These holdings will be between different countries, currencies and sectors. They will also be between different asset classes - cash, corporate and government bonds and equity holdings in large corporations. With all due to respect to the fund managers, how can a manager really be expected to have expertise about the workings of several hundred companies in dozens of sectors of the economies of perhaps twenty to thirty countries? It is difficult to imagine anyone being so skilled... Large funds do this because of the responsibility they have to maintain purchasing power for thousands of people. With such responsibility comes very significant constraints to their investment style. However, as a private investor, these constraints do not apply and so it would seem more appropriate to learn about and understand the thoughts on this subject of luminaries such as Keynes and Buffett than the prevailing wisdom in the financial services sector. Would you like to increase your trading profits? You would? Then please click here to read about this excellent
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