# Concentration is better than diversification



## dub_nerd (19 Dec 2016)

Here's a view which coincides with what I've been thinking for some time (and therefore may be an example of extreme confirmation bias on my part  ). Jim Rogers, co-founder with George Soros on the Quantum Fund says: "diversification is just something that brokers came up with, so they don't get sued. If you want to get rich ... you have to concentrate and focus."

https://news.thestreet.com/independ...ogers-on-why-not-to-diversify-portfolios.html

In this view, it's _not_ all about length of time in the market. That'll just get you plodding returns (like the 2% my pension returned in the last year). My big gripe, though, is that diversification doesn't actually protect you. Yes, it'll save you from company- and industry-specific risk, but as long as you steer clear of stupid stuff the biggest risk by far is market risk which you can't really protect against.

So looking out for value buys and concentrating on a very small number of stocks seems to me to be reasonably sensible. So far I've managed to make a return of about 20% in six months while testing this strategy, though obviously that is much too short a time period to draw any inferences.


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## cremeegg (19 Dec 2016)

dub_nerd said:


> Here's a view which coincides with what I've been thinking for some time (and therefore may be an example of extreme confirmation bias on my part  ). Jim Rogers, co-founder with George Soros on the Quantum Fund says: "diversification is just something that brokers came up with, so they don't get sued. If you want to get rich ... you have to concentrate and focus."
> 
> https://news.thestreet.com/independ...ogers-on-why-not-to-diversify-portfolios.html
> 
> ...



You can be a passive investor or a stock picker. They are two completely different things.

Of course diversification will not help you get excellent returns, thats like saying, this golf club doesnt make my rally car go any faster. For a passive investor diversification is a free lunch, it protects you against certain risks, free of charge, that's a marvellous thing. It can protect you against business risk, against industry risk, against currency risk, against geographical risk. Its true that it cannot protect you against systemic risk, but thats like saying, this golf club was useless when the golf course flooded.

But you didn't want to play golf, you wanted to go rallying.

Absolutely diversification has little value for the stock picker. With stock picking why should you put money in the second best investment opportunity? However it is a simple matter of arithmetic that the average euro invested by a stock picker will make a market return and less after costs. Of course that average hides many above average returns, Jim Rodgers for example, and many below average returns, you for example ?

More than golf or rallying, stock picking is like playing chess, anyone can learn how its done, lots of study and time can make you better at it, not many people become world champions.


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## Brendan Burgess (20 Dec 2016)

dub_nerd said:


> So looking out for value buys and concentrating on a very small number of stocks seems to me to be reasonably sensible.



No, it's not sensible at all. 

It might be for Jim Rogers or Warren Buffett, but it's crazy for 99.99% of people. 



dub_nerd said:


> So far I've managed to make a return of about 20% in six months while testing this strategy, though obviously that is much too short a time period to draw any inferences.



The fact that you would even refer to 6 months' returns, suggests to me that you should not be doing anything other than investing in a broad, diversified, portfolio of shares. 

Brendan


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## Gordon Gekko (20 Dec 2016)

Here's my take on how to "get rich":

- Take a big concentrated binary bet in a sector you know like the back of your hand (e.g. set up a business), or

- Optimise your income and your assets from an asset allocation and tax perspective and then invest in a diversified manner.

Think about the two great tax breaks, PPR Relief and pensions. The power to compound wealth tax free in a pension is huge. And it's easy to forget that 7% a year doubles your money after 10 years. You don't need to achieve 20% returns (and to do so, the risks are off the scale).


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## dub_nerd (20 Dec 2016)

Can't be certain, but I'm not sensing a whole lot of agreement with my position. 

Just added another batch of shares to my highly non-diversified portfolio. 
Will let you know how it goes next year.


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## Brendan Burgess (20 Dec 2016)

dub_nerd said:


> Will let you know how it goes next year.



You will have to wait around 20 years to have any meaningful evidence that any out-performance or under-performance is due to anything other than the randomness of returns.

Brendan


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## cremeegg (20 Dec 2016)

Brendan Burgess said:


> You will have to wait around 20 years to have any meaningful evidence that any out-performance or under-performance is due to anything other than the randomness of returns.
> 
> Brendan



I dont agree with this at all. The whole point about picking a single share is that it avoids the randomness of returns. 

If I think share X is undervalued and buy into it with a 6 months time horizon, I am entitled to regard the profit or loss I make beyond the market return as down to my skill and courage. Luck of course plays a part but that is true in any area of human endeavour.

One success or failure of course does not prove that there will be a consistent pattern into the future.


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## cremeegg (20 Dec 2016)

I just read the title on this new thread.

Concentration is better than diversification. Well given the season thats in it, the obvious answer is, "Oh No it isn't"

If fact I think the point is that they are two completely different things, diversification is an excellent for a passive investor. For a successful stock picker diversification will put a drag on returns. Wether, you me or anyone else will be a successful stocker into the future I have no idea.


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## Gordon Gekko (20 Dec 2016)

cremeegg said:


> I dont agree with this at all. The whole point about picking a single share is that it avoids the randomness of returns.
> 
> If I think share X is undervalued and buy into it with a 6 months time horizon, I am entitled to regard the profit or loss I make beyond the market return as down to my skill and courage. Luck of course plays a part but that is true in any area of human endeavour.
> 
> One success or failure of course does not prove that there will be a consistent pattern into the future.



What it doesn't avoid is potential wealth devastation. Plenty of excellent companies have been hammered because of one-off issues (e.g. Volkswagen with emissions, Tesco with accounting). Apple's a great company, but who's to say that smartphones won't start exploding or be linked to dementia?

People in other countries (e.g. the UK/US) where there is a greater history of wealth preservation and wealth creation have it copped. Aim to compound away at 5-7% over time and you'll be laughing.


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## dub_nerd (20 Dec 2016)

Brendan Burgess said:


> You will have to wait around 20 years to have any meaningful evidence that any out-performance or under-performance is due to anything other than the randomness of returns.
> 
> Brendan


I may be a naive and inexperienced investor but I _do_ know my maths. 
You'd have to define "meaningful" and then pick a metric but, for example, the chances of outperforming the market every year for twenty years by random chance are a million to one. We can use combinatorics to assign a probability to any given number of years of outperformance, e.g. a one in four chance of outperforming for 12 or more years out of 20. That's just assigning a binary chance of being higher or lower than the average market each year. If you assign weights to the degree of outperformance you should be able to make a determination in much less than 20 years. Obviously it's always impossible to rule out pure dumb luck -- that's the nature of probability.


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## PGF2016 (20 Dec 2016)

dub_nerd said:


> So far I've managed to make a return of about 20% in six months



Six months? That's almost like saying you're the better team when you're one nil up after 2 minutes. The game has only just begun.


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## dub_nerd (20 Dec 2016)

PGF2016 said:


> Six months? That's almost like saying you're the better team when you're one nil up after 2 minutes. The game has only just begun.


If you're one-nil up after two minutes it doesn't make you the better team, but it certainly increases the probability that you are. What level of evidence would you consider significant?


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## RichInSpirit (20 Dec 2016)

dub_nerd said:


> Can't be certain, but I'm not sensing a whole lot of agreement with my position.



Don't worry Dub Nerd ! I'm in total agreement with you
And you know your Maths ! The maths is most important


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## Steven Barrett (20 Dec 2016)

dub_nerd said:


> "diversification is just something that brokers came up with, so they don't get sued. If you want to get rich ... you have to concentrate and focus."



He's right. Diversification reduces risk exposure. No one can predict the top performing region or sector year on year. Diversification merely reduces the wide volatility that you are exposed to by having a concentrated portfolio. 

If you had two funds, one returned 10% each year for 10 years. The other returned 20% for 7 years and lost 20% for another 3 (sequence doesn't matter), which would you go for? 

The 10% option returns over 40% of the 20% option. Concentrated stock picking is liable to give you the same result. You can get the really exciting highs but you are very open to the devastating lows too (like a drug!!). 

Then we get to have you got the skill to pick the correct stock? Active fund managers have highly skilled people and millions in resources. They talk to CEO's, they talk to their competitors, the do tons of research before buying stock. And even still, they get things wrong a lot of the time. You are competing against these professionals. Are you going to put the same time and effort into analysing a company before buying? Where are you going to start? 


Steven
www.bluewaterfp.ie


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## PGF2016 (21 Dec 2016)

dub_nerd said:


> If you're one-nil up after two minutes it doesn't make you the better team, but it certainly increases the probability that you are. What level of evidence would you consider significant?


A full season. 90 minutes * 38 games. 

In investing that would be 20 years at least.


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## dub_nerd (21 Dec 2016)

dub_nerd said:


> If you're one-nil up after two minutes it doesn't make you the better team, but it certainly increases the probability that you are. What level of evidence would you consider significant?





PGF2016 said:


> A full season. 90 minutes * 38 games.
> 
> In investing that would be 20 years at least.



Ok, so not trying to be smart or anything, but now let's get down to where you plucked 20 years from (same as Brendan previously). Is it because it _sounds_ like a long time? Let's try to be a bit more scientific. If someone -- using whatever strategy of their choice -- has a random chance of being ahead of or behind the market at the end of each year, then the chances are a million to one against them beating the market every year for 20 years in a row (a million being the twentieth power of two). I don't think we need anything like that level of certainty to demonstrate that their strategy has something going for it. I'm not even suggesting that this binary end-of-year measurement is the right way to do it, but we have to have some metric, otherwise it's just completely arbitrary.


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## Gordon Gekko (21 Dec 2016)

Take the US market over the course of its history (I think it's 1871 to present day).

Taking a one day time horizon, and all observations over the period, investors have been up 52% of the time. Not far off a coin toss.

However, taking any 20 year time horizon, an investor has NEVER been down.


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## dub_nerd (21 Dec 2016)

SBarrett said:


> Concentrated stock picking is liable to give you the same result. You can get the really exciting highs but you are very open to the devastating lows too (like a drug!!).


Good point, Steven. Maybe I'm just trying to inject a bit of stimulation. I do have to admit the thought of slapping my cash in someone else's fund makes my eyes glaze over a bit. I want to have a bit of fun with this.



SBarrett said:


> Then we get to have you got the skill to pick the correct stock? Active fund managers have highly skilled people and millions in resources. They talk to CEO's, they talk to their competitors, the do tons of research before buying stock. And even still, they get things wrong a lot of the time. You are competing against these professionals. Are you going to put the same time and effort into analysing a company before buying? Where are you going to start?


Also good questions. Part of my answer is that the fund manager _has_ to stay invested all the time. To quote one of them: "there's no other game in town".  I, on the other hand, don't have to. My needs are few. I can cherrypick the best value buys or I can stay away altogether. Ok, I still have to figure out what they are, but with only needing to trade a handful of times a year I can buy the significant dips (along with learning a bit of analysis along the way). And let's not forget that most active fund managers don't outperform the market either.


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## PGF2016 (21 Dec 2016)

dub_nerd said:


> Ok, so not trying to be smart or anything, but now let's get down to where you plucked 20 years from (same as Brendan previously). Is it because it _sounds_ like a long time? Let's try to be a bit more scientific. If someone -- using whatever strategy of their choice -- has a random chance of being ahead of or behind the market at the end of each year, then the chances are a million to one against them beating the market every year for 20 years in a row (a million being the twentieth power of two). I don't think we need anything like that level of certainty to demonstrate that their strategy has something going for it. I'm not even suggesting that this binary end-of-year measurement is the right way to do it, but we have to have some metric, otherwise it's just completely arbitrary.


20 years is absolutely arbitrary. As is 6 months. There's nothing scientific about it. 

You mention 'beating the market every year'. Why are you using an arbitrary time frame like a year? It just happens to be the time it takes the earth to orbit the sun. What has it got to do with investing? 

I suppose the 'best' time frame is the amount of time it takes to reach your investing goal. If you're able to cash out and retire with market beating performance then I'd say you're strategy has worked. Until then it's still under investigation. 



Gordon Gekko said:


> Take the US market over the course of its history (I think it's 1871 to present day).
> 
> Taking a one day time horizon, and all observations over the period, investors have been up 52% of the time. Not far off a coin toss.
> 
> However, taking any 20 year time horizon, an investor has NEVER been down.



This is an excellent reason to use a 20 year time frame.


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## cremeegg (21 Dec 2016)

The title of this thread is concentration vs diversification.

Diversification is part of accepting the idea of the efficient market.

There are two different reasons why you might move away from the efficient market idea.

1. To an alternative market view, which involves a rule or scheme to underpin investment choices. Value investing, growth investing, dogs of the dow, sell in May, are all examples. While they may move away from full diversification none of these involve concentration as desirable in itself. All of these involve the idea that there is a better way to value shares on a *systematic* basis than the efficient market theory. A long term test makes some sense toward such an approach.

2. To the idea that on a share by share basis you can sometimes spot errors in the market price. There is no rule or scheme involved here. Just a view that share X is mispriced by the market. One share may be mispriced for one reason another share mispriced for a different reason. You might be right on one occasion and wrong on the next occasion, there is no valid test for such an approach. Concentration is essential to this approach.

The question which is better, diversification or concentration, is based on a false premise. Each has a different function.

If you want the markets to work for you then you should diversify. If you think you can identify market errors, then you must concentrate.


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## Steven Barrett (21 Dec 2016)

dub_nerd said:


> Good point, Steven. Maybe I'm just trying to inject a bit of stimulation. I do have to admit the thought of slapping my cash in someone else's fund makes my eyes glaze over a bit. I want to have a bit of fun with this.




_Lethargy bordering on sloth remains the cornerstone of our investment style: This year we neither bought nor sold a share of five of our six major holdings." - _Warren Buffett, the world's most successful investor. 

Having fun has nothing to do with it. It's capturing the power of compounding that will make you money, not the thrills of highs and lows. Boring is better. 




dub_nerd said:


> Also good questions. Part of my answer is that the fund manager _has_ to stay invested all the time. To quote one of them: "there's no other game in town".  I, on the other hand, don't have to. My needs are few. I can cherrypick the best value buys or I can stay away altogether. Ok, I still have to figure out what they are, but with only needing to trade a handful of times a year I can buy the significant dips (along with learning a bit of analysis along the way). And let's not forget that most active fund managers don't outperform the market either.



Not everyone has to stay invested, plenty of fund managers can move to cash if they want to (remember, you are competing against every fund manager in the world). But you said lots of other interesting things: 

You can cherrypick the best value buys - how will you know they are the best value? What level of analysis are you carrying out to come to this conclusion? Remember, you are competing against companies that have millions in resources and lots of experienced analysts to analyse the same stock. How can you do better? 

You ca buy the significant dips - are you going to try to time the market? How are you going to do this? You may get lucky once or twice but overall, timing the market is a mugs game. Bounces in markets tend to happen pretty quickly. Missing even the best 5 days of market returns over a 20 year period can cost you 2% per annum. 

Yes, fund managers don't perform the market. They are professionals and are still unsuccessful, why do you think you can do better? Try to capture the market. If you are going to take a concentrated approach and want to make money, pick the top 5 companies off a small cap index and strap yourself in for the ride. 

Steven
www.bluewaterfp.ie


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## cremeegg (21 Dec 2016)

SBarrett said:


> _Lethargy bordering on sloth remains the cornerstone of our investment style: This year we neither bought nor sold a share of five of our six major holdings." - _Warren Buffett, the world's most successful investor.
> 
> Having fun has nothing to do with it. It's capturing the power of compounding that will make you money, not the thrills of highs and lows. Boring is better.



Having fun has everything to do with it. I think Warren Buffett has more fun than most. Making and backing your own decisions is lots of fun.



SBarrett said:


> You can cherrypick the best value buys - how will you know they are the best value? What level of analysis are you carrying out to come to this conclusion? Remember, you are competing against companies that have millions in resources and lots of experienced analysts to analyse the same stock. How can you do better?



If anyone wants a start on actually answering this question, I suggest Jim Slater's book "The Zulu Principle"


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## dub_nerd (21 Dec 2016)

Gordon Gekko said:


> Take the US market over the course of its history (I think it's 1871 to present day).
> 
> Taking a one day time horizon, and all observations over the period, investors have been up 52% of the time. Not far off a coin toss.
> 
> However, taking any 20 year time horizon, an investor has NEVER been down.



I'm not sure that tells us anything much. There are lots of noisy data sequences that show a general trend (e.g. sea surface temperatures, change of day length due to tidal dissipation etc. etc.). So what happens if we take a random sample of days from a twenty year sequence of market data and ignore the rest? My guess is the trend will still be up. Of course, it will depend on how sparse your sample is, with greater divergences the more sparse you go. 



PGF2016 said:


> 20 years is absolutely arbitrary. As is 6 months. There's nothing scientific about it.
> 
> You mention 'beating the market every year'. Why are you using an arbitrary time frame like a year? It just happens to be the time it takes the earth to orbit the sun. What has it got to do with investing?


Absolutely nothing. That's why I said I wasn't suggesting this as the metric. I was just challenging the people who were saying "20 years" to come up with some quantifiable metric.



PGF2016 said:


> I suppose the 'best' time frame is the amount of time it takes to reach your investing goal. If you're able to cash out and retire with market beating performance then I'd say you're strategy has worked. Until then it's still under investigation. This is an excellent reason to use a 20 year time frame.


But I've already cashed out and retired, and I certainly didn't use anything as chaotic and arbitrary as the stock market to achieve it. So I don't have an investing goal, as such. It's more a kind of learning experiment.



cremeegg said:


> Diversification is part of accepting the idea of the efficient market...
> 
> The question which is better, diversification or concentration, is based on a false premise. Each has a different function.
> 
> If you want the markets to work for you then you should diversify. If you think you can identify market errors, then you must concentrate.



I'm not sure I accept your first premise. Diversification is a way of avoiding certain types of risk. Apart from that, it guarantees that you will not achieve the best returns available, since by definition an average can never be as good as the best. But I accept your other points. And I suppose my view is that the markets are only efficient in the medium term, and highly sentiment driven in the short term. You will find lots of successful investors who say you need to be doing what everyone else isn't. I've taken an element of this approach and found it useul so far.



SBarrett said:


> _Lethargy bordering on sloth remains the cornerstone of our investment style: This year we neither bought nor sold a share of five of our six major holdings." - _Warren Buffett, the world's most successful investor.
> 
> Having fun has nothing to do with it. It's capturing the power of compounding that will make you money, not the thrills of highs and lows. Boring is better.



Ah, but we're in violent agreement here. I'm not advocating a whirlwind of frequent trading either.



SBarrett said:


> You can buy the significant dips - are you going to try to time the market? How are you going to do this? You may get lucky once or twice but overall, timing the market is a mugs game. Bounces in markets tend to happen pretty quickly. Missing even the best 5 days of market returns over a 20 year period can cost you 2% per annum.


It's possible this year has been an exceptional year. The market has reacted ridiculously negatively to various events -- Brexit, Trump, Fed announcements etc. I've made some nice gains from that. People always talk about the efficient market, but over short periods sentiment has a huge bearing (in my limited experience).



SBarrett said:


> Yes, fund managers don't perform the market. They are professionals and are still unsuccessful, why do you think you can do better? Try to capture the market. If you are going to take a concentrated approach and want to make money, pick the top 5 companies off a small cap index and strap yourself in for the ride.


We're in violent agreement again. Am doing some of that for next year.

Thanks folks -- very useful and interesting to bounce this stuff around, hope I'm not offending anyone's sensibilities.


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## Gordon Gekko (21 Dec 2016)

That is nonsense. Markets have reacted positively to Trump's election. You're making it up as you go along.


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## dub_nerd (21 Dec 2016)

Gordon Gekko said:


> That is nonsense. Markets have reacted positively to Trump's election. You're making it up as you go along.


They didn't on the morning of November 9th. It was a pretty short blip admittedly, but why would I make it up?


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## Duke of Marmalade (21 Dec 2016)

My tuppence worth.

Why invest in the stockmarket at all?  Not because you are investing in real assets which deliver real economic benefit, that seductive old chestnut. You are buying in a second hand market so these fundamentals are completely subsidiary to whether you are getting a good price.  Apple is I am sure  a wonderful company with lots of highly skilled tax advisers as well as some techies.  But whether Apple is therefore a good investment depends entirely on its price.

There is past evidence that because of the various risks attaching, both short term and long term, the market does price in a "risk premium" for equity investment.  Each individual will have a sense of whether she requires less or more risk premium than the generality of market participants.  Thus if she has a long term objective and is untroubled by short term volatility she could reasonably take the view that the market is providing unnecessary compensation for that short term volatility and she is therefore getting a free lunch.

On the other hand, if for whatever reason she is much more perturbed by short term volatility than the average market participant, she is not getting sufficient compensation, and stockmarket investment is not for her.

The theory goes that the market gives no compensation whatsoever for idiosyncratic risk because that can be diversified away.  Thus if you chose to concentrate you are taking on extra risk with no expectation of a market compensation for that risk.  But you may not need compensation for the extra risk,  you may actually want the risk for it is true that diversification will deliver you only the average return, and risk is for the upside as well as the downside. Arguably, if you are in this latter category you are more of a gambler than an investor.

I agree totally with _SBarrett_ that none of us have an inherent skill in picking stocks.  _dub_nerd_ has been lucky over the recent past, but I will never, ever believe she did this on merit, not even if she earns 20% for each of the next 40 six month periods

As a secondary point, the Duke has a view that with the unprecedented intervention in the financial markets by Central Banks (QE), markets are not pricing in much, if any, risk premium at the present time.


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## dub_nerd (21 Dec 2016)

Good post Duke. However, this bit is nuts:



Duke of Marmalade said:


> I agree totally with _SBarrett_ that none of us have an inherent skill in picking stocks.  _dub_nerd_ has been lucky over the recent past, but I will never, ever believe she did this on merit, not even if she earns 20% for each of the next 40 six month periods



Everyone must sometime deal with statistical evidence, and making five times the average market return every year for 20 years would render it a practical impossibility that there wasn't some successful strategy being employed. (Not that I remotely expect to do that! )


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## Duke of Marmalade (21 Dec 2016)

_dub_nerd_ it is a question of Bayesian a priori assumption (are you impressed?).  For example, my a priori assumption is that the chances of having a skill in picking winning lotto numbers is 0%. If my next door neighbour wins the jackpot and claims it was skill then, despite the statistical chances of him winning being millions to one, I would still insist that he had no skill in the matter despite the statistical evidence.

Now, do I a priori believe that the chances of _dub_nerd_ having a (meaningful) skill in picking stockmarkets are 0% (nothing personal I assure you).  Well yes, close on, so no amount of statistical evidence will persuade me otherwise.


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## Rory T Gillen (21 Dec 2016)

The best returns can accrue to those who can identify undervalued assets consistently. But I doubt that's the amateur, but rather the professional investor. If you commit the time, effort and patience to becoming a professional investor you have a chance. Anything else is either arrogance or ignorance.

I'm with Brendan on this one. For the vast majority of retail/private investors diversification is important because it diversifies risk, and if one is honest it is tricky to understand or identify risk; in individual stocks this means the business, financial and valuation risks. If all stocks are overvalued, diversification within equities does not necessarily lower your risk. For that you need an asset that both offers some value and generates its returns in a way that is not related to how stocks generate them; by investing in, say, government bonds. Diversifying into other asset classes lowers risk as it reduces one's dependence on the economy for returns - the economy drives the majority of returns delivered by equities and property. If an economy is going into recession, for example, corporate earnings will suffer, and stock markets will most likely be falling. But such an environment benefits government bond prices as investors seek them out for their safety of principle and pre-determined interest (Greece, Russia et all excepted!). So owning both stocks and government bonds can lower risk. Returns may be lower too, but that's the price for reduced risk.


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## Jim2007 (22 Dec 2016)

SBarrett said:


> Yes, fund managers don't perform the market. They are professionals and are still unsuccessful, why do you think you can do better?



Being a professional fund manager does not imply one is a skilled investor!  Assuming the funds constituents are known and publicly traded there is no reason that a knowledgeable person could not out perform a fund manager on a regular basis, but that does not mean that the individual is skilled investor either.  It just means the deck is stacked against the fund manager!

The fund manager starts out with several disadvantages:
- first there is the regulations which may prevent you from fully replicating the benchmark 
- next comes the float, this is the percentage of the fund that needs to be in cash to account for the exiting investors 
- then there is the need to attract and keep investors, so you better be holding what's trending or you'll be in trouble 
- retros can also become an issue with distributors as well
These are just some of the things the fund manager has to overcome to achieve the benchmark.


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## Brendan Burgess (22 Dec 2016)

Jim2007 said:


> - retros can also become an issue with distributors as well



Hi Jim

Very interesting analysis.

What are "retros"?

Brendan


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## dub_nerd (22 Dec 2016)

Duke of Marmalade said:


> _dub_nerd_ it is a question of Bayesian a priori assumption (are you impressed?).  For example, my a priori assumption is that the chances of having a skill in picking winning lotto numbers is 0%. If my next door neighbour wins the jackpot and claims it was skill then, despite the statistical chances of him winning being millions to one, I would still insist that he had no skill in the matter despite the statistical evidence.


Yes, very impressed, Duke 

However, the whole point of Bayes' Theorem is that you are supposed to update your belief based on the evidence. The _a priori_ odds of your neighbour winning the lottery may be a million to one, but if he comes to you and tells you _in advance_ that he's going to win it that very night _and he does_ ... then you would be right to strongly suspect that he has some sort of system going. The people who funded the MIT students' lottery syndicate did not think the odds of winning the lottery were a million to one. They might have worried that they were the victims of some sort of elaborate wire fraud, but they'd have been silly to worry that the students' success was based on pure luck with all the evidence to the contrary.



Duke of Marmalade said:


> Now, do I a priori believe that the chances of _dub_nerd_ having a (meaningful) skill in picking stockmarkets are 0% (nothing personal I assure you).  Well yes, close on, so no amount of statistical evidence will persuade me otherwise.


But forget about me for a minute. Would you accept that within the stock markets there is a continuum of risk available to investors, and that some investors may do better or worse than the average by choosing their level of risk? And perhaps part of that continuum of risk is the choice of level of diversification?


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## Duke of Marmalade (22 Dec 2016)

_dub_nerd_ forget the Bayesian stuff, that was just a bit of festive banter
There is a popular fallacy that risk implies reward or rather the expectation of reward.  A clear counterexample is walking blindfold across a busy motorway.  Extremely risky with very high negative expectation of rewards.

Now second hand financial markets could plausibly reward risk through the pricing mechanism.  That is, the higher the risk the lower the price and ergo the greater prospects for reward.  However, the theory goes that if a risk can be diversified away the price will rise to a level which does not reward this diversifiable (idiosyncratic) risk. 

Yes there is a continuum of risks in the market.  But if you concentrate you will inevitably incur risk which the main market can ignore because they can diversify it away, so you can expect no extra reward for taking on that extra risk.

All very theoretical EMH stuff but I for one, and I think I can read a balance sheet as well as the next guy, have no illusions that I will ever be able to pick out stocks with a higher reward expectation (i.e. priced cheaply).


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## dub_nerd (22 Dec 2016)

I accept all that Duke, but what I've been doing has not much to do with reading balance sheets. That would imply holding stocks across entire reporting periods. I'm more interested in significant swings that seem to depend primarily on market sentiment. The market may be efficient in the long run, but it spends plenty of time being an emotional wreck . I'm looking for swings of 5% to 10% in a stock and aim to hold it for no more than a couple of weeks. One stock (which shall remain nameless) yielded me 18% by holding it for about 8 weeks total over a few months, with the stock price the same at the end of the period as the beginning.


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## Fella (22 Dec 2016)

I get what your doing dub_nerd , I think it's possible to beat the market return doing what you do, there are traders that do.

I beat Betfair similar strategies and have done every month or so for nearly 10years it's possible to beat efficient markets with the right strategy.

If you look at the trump odds to be president there where days where trump started the day 5/2 on Betfair and finished the day 5/2 on Betfair but in a million might of been matched on that day and there where people like myself that made lots on that day.

I'm just a little confused with your posts it's like comparing apples and oranges imo. It reads to be that you have a small hobbie trading markets using news and your opinion but your debating with people who are investing for pensions and future that want market returns.

Personally I do both and don't count them the same way , so I've 90% of my money in investment trusts which I just add to regularly it's not up that much it's been up and down but when Sterling got weaker it didn't help. But I have 20k fun money I split this up and use it for trading , I'm up nearly 50% on this money I think I'm using similar strategies that you are. The problem I see with this money is eventually I'm liable to end up with a lot of dogs that I bought and ended up holding onto and price never came back , so I don't really have a concrete plan as such so would never use the 90% of my money on this strategy. When I traded Betfair the markets where not infinite so you either got out at 70mins at a loss in football or waited to 90mins and lost it all. 
So at the moment I'm taking kinda scalping the stock market not for huge swings but I've sold the winners at profit but the couple of losers I'll be left with, so long term what I see happening is an extended bad news after bad news will see me running out of liquidity to buy more and miss the next upturn or long term say for every 5 new stocks I buy if one doesn't come back I'll quickly end up with all my money locked up on the losers . ( hope that makes sense !)

Of course you can make money been a trader doesn't matter what you buy or sell it's more important when you buy and sell .


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## Duke of Marmalade (22 Dec 2016)

Jim2007 said:


> Being a professional fund manager does not imply one is a skilled investor!  Assuming the funds constituents are known and publicly traded there is no reason that a knowledgeable person could not out perform a fund manager on a regular basis, but that does not mean that the individual is skilled investor either.  It just means the deck is stacked against the fund manager!
> 
> The fund manager starts out with several disadvantages:
> - first there is the regulations which may prevent you from fully replicating the benchmark
> ...


Interesting points.  But note that the "problems" arise because the fund is open, open to exits and open to new business.  Closed UK Investment Trusts have neither of these disadvantages and also because they are taxed at CGT pus Income Tax, much better than open Exit Tax funds.


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## dub_nerd (23 Dec 2016)

Fella said:


> I'm just a little confused with your posts it's like comparing apples and oranges imo. It reads to be that you have a small hobbie trading markets using news and your opinion but your debating with people who are investing for pensions and future that want market returns.


Yes and no. I retired just after my mid forties, not sure if it's forever, wouldn't mind making some more money from investments but not prepared to jeopardise retirement altogether if I can help it. So it's a good bit more than a hobby but less than life-changing.



Fella said:


> Personally I do both and don't count them the same way , so I've 90% of my money in investment trusts which I just add to regularly it's not up that much it's been up and down but when Sterling got weaker it didn't help. But I have 20k fun money I split this up and use it for trading , I'm up nearly 50% on this money I think I'm using similar strategies that you are.



I've got about 80% in cash, and 20% in stocks of which 20% of that is in sensible investment trusts. That still leaves a substantial amount of money that I've been trading. It's been doing moderately well. I'm not a huge spender, so actually it's been earning more than my entire outgoings. But that could be just luck. I guess that's what I'm trying to find out here. The likelihood that I've found some magic winning formula that has eluded everyone else is nil. My best theory so far is that this year's market volatility is exceptional. In a boring steadily rising market I'd probably be shut out, looking for dips worth buying.



Fella said:


> The problem I see with this money is eventually I'm liable to end up with a lot of dogs that I bought and ended up holding onto and price never came back , so I don't really have a concrete plan as such so would never use the 90% of my money on this strategy.


Yes, same here. Fortunately I only have one dog from a couple of years back when I really had no idea what I was doing. In my naive way of thinking, if you can make 50% returns on 20% of your money, that still represents a pretty decent return on _all_ of your money. On the other hand, if you only have 20% of your money invested you are not subject to the same level of market risk. I think that's where I differ from the other people on this forum. They need diversification to offset company- and sector-specific risk, presumably because they've got a big proportion of their assets invested. They are not protected from market risk, but that's ok if you have a long investment horizon. I'm not afraid of concentration in an attempt to get bigger gains on a smaller outlay, but am not prepared to risk everything.



Fella said:


> So at the moment I'm taking kinda scalping the stock market not for huge swings but I've sold the winners at profit but the couple of losers I'll be left with, so long term what I see happening is an extended bad news after bad news will see me running out of liquidity to buy more and miss the next upturn or long term say for every 5 new stocks I buy if one doesn't come back I'll quickly end up with all my money locked up on the losers . ( hope that makes sense !)


Yeah, makes total sense. My approach with the losers is to bite the bullet and sell them at a loss. As you say, otherwise you will watch the other stocks rising that you could have been invested in, while you remain hitched to the wrong wagon. It doesn't always work out. I took a loss on a stock that would have been in a five-figure profit two days later. In another case I sold at a loss, then bought back in later at an even lower price and ended up with a decent gain. I try not to waste time lamenting the "ones that got away". 

Obviously this strategy is fatally flawed if you have a bad enough string of losses. You'll be like the guy at the roulette table doubling down on red at every spin. Probability dictates that you will run out of liquidity at some point. I'm trying to find out if that is the inevitable long term result, or if there is a way to maintain enough of an advantage (through knowledge of market value) to keep ahead.


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## Steven Barrett (23 Dec 2016)

Duke of Marmalade said:


> There is a popular fallacy that risk implies reward or rather the expectation of reward.  A clear counterexample is walking blindfold across a busy motorway.  Extremely risky with very high negative expectation of rewards.



Don't go around saying things like that!!  We have a hard enough time explaining investment risk without you throwing in walking across motorways blindfolded!!

Indexes or a good fund manager are a good way of separating the good risk from the bad risk. Knowing that while Greece is offering 19% interest on its 10 year bonds but the chances are you won't get your money back. That 90% of companies in Silicon Valley will fail before you get the one massive return from the next Uber. Unfortunately, a lot of people are blinded by the 19% annual return or reading how someone invested in Uber and made a fortune without knowing about all the other companies they lost all their money on.


Steven
www.bluewaterfp.ie


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## IsleOfMan (23 Dec 2016)

dub_nerd said:


> So looking out for value buys and concentrating on a very small number of stocks seems to me to be reasonably sensible. So far I've managed to make a return of about 20% in six months while testing this strategy, though obviously that is much too short a time period to draw any inferences.



I did this myself for a period of time. I concentrated on about a dozen U.K. shares. Read everything about them. Knew everything about them. I watched their live trades online daily. Making money.

Unfortunately I got bored. Started talking to other people. Added a few shares I knew little about. 30 trades of profit in a row were wiped out with one big loss.

Trying to discipline yourself and not getting to believe that you are invincible becomes a daily battle.


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## Jim2007 (23 Dec 2016)

dub_nerd said:


> I took a loss on a stock that would have been in a five-figure profit two days later. In another case I sold at a loss, then bought back in later at an even lower price and ended up with a decent gain.



So you have a problem in stock valuation, which is the case with most average investors and why they should be index investors rather than buying individual stocks.


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## Jim2007 (23 Dec 2016)

Duke of Marmalade said:


> Interesting points.  But note that the "problems" arise because the fund is open, open to exits and open to new business.  Closed UK Investment Trusts have neither of these disadvantages and also because they are taxed at CGT pus Income Tax, much better than open Exit Tax funds.



Closed funds are consistently undervalued, subject to a break up if in fact they do hold anything of real value and are a captive audience when it comes to fee generation.


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## Duke of Marmalade (23 Dec 2016)

Jim2007 said:


> Closed funds are consistently undervalued, subject to a break up if in fact they do hold anything of real value and are a captive audience when it comes to fee generation.


Interesting points _Jim_ but it is not because they are closed that they are undervalued.  It is because they are traded in the market.  If open funds were similarly priced they too would be undervalued.

Take the Aberdeen UK Tracker Trust - sorry Boss I know it is an individual share but I use it in the interests of academic research into the merits of diversification  Its share price stands at a 3.5% discount to its NAV.  Why?  One possible reason is the fees but at an all in 0.29% p.a. that hardly justifies a 3.5% discount. In any case it has been extremely good at tracking the FTSE All Share so performance doesn't justify the discount.

No, the reason is that the sum of the parts taken individually  is worth slightly more to the market than their sum taken collectively.  In other words the market requires a discount for diversification.  This is not to negate my earlier comments that the market does not give a premium for diversifiable risk.

Let me try a very strained metaphor.  Most sweets are sold in individual packs e.g.  smarties, polo mints, maltesers etc.  Now if one tried to sell a combo pack of say 10 different sweets there would be two contrasting reactions.  There would be those who welcome the variety, i.e. who don't like too much of the same thing.  These are the diversifiers.  But there will be many who will be put off because say one of the combo just doesn't take their fancy and this is not compensated by the variety.  These are the NAV discounters.  So in answer to OP, yes I can see how some investors would be concentrators, but for those who just don't have the time or inclination diversification seems to be the correct option.  I still don't believe anybody has an intrinsic skill for picking winners.

On the captive management, I'm not sure I buy the point.  The investment manager of the £330M AUKT is cited as David Jones.  I would say David is extremely committed to achieving the fund's goals i.e. to match or FTSE All Share, his job depends on it,  and the results over recent years support that view.

BTW as a side point, was it ever sorted out whether Exit Tax will fall in line with DIRT over the next four years. I really think Exit Tax funds are bad news.


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## Jim2007 (23 Dec 2016)

Duke of Marmalade said:


> Take the Aberdeen UK Tracker Trust



At £330m, you are talking about a penny stock!  It's under performing, illiquid and small enough to be easily manipulated should it ever do anything interesting. This has the illusion of being the same as investing in the FTSE where as in reality you've upped the risk factor and reduced the risk premium.


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## Duke of Marmalade (23 Dec 2016)

Jim2007 said:


> At £330m, you are talking about a penny stock!  It's under performing, illiquid and small enough to be easily manipulated should it ever do anything interesting. This has the illusion of being the same as investing in the FTSE where as in reality you've upped the risk factor and reduced the risk premium.


I didn't particularly want to be sidetracked into being a promoter of AUKT but I think the above assessment is a tad harsh.  It has given a total return of 52.4% in the 5 years to November 30th, versus the FTSE All Share of 55.4%.  It is extremely difficult to match an index as index construction ignores all costs including those of rebalancing.  Indeed the closer you actually replicate the index the more certain you are to underperform it.  In AUKT's case the tracking slippage seems very acceptable and I doubt whether much larger tracking funds have done any better.  I am no longer in AUKT but I got in and out of the share between 2013 and 2015.  On both entry and exit I found that I got very close to the quoted price so at the modest c.£50k levels that I was trading liquidity seemed to be adequate.

And of course being so small there is always the possibility that a much greater competitor will gobble it up and that would have the effect of largely releasing the discount to NAV.


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## Jim2007 (24 Dec 2016)

Duke of Marmalade said:


> I didn't particularly want to be sidetracked into being a promoter of AUKT but I think the above assessment is a tad harsh.



No it is simply applying the investment criteria without emotion.  Every so often we get people on here complaining about loosing serious money in some fund or other.  And of course on a human level you have to sympathize.  But if you look at their action you will almost always find that they would never have got involved in it in the first place!  If you through the play book out the window when it comes to applying the strategy the you should not be surprised if it does not work out as expected.


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## sunnydonkey (25 Dec 2016)

dub_nerd said:


> Jim Rogers, co-founder with George Soros on the Quantum Fund says: "diversification is just something that brokers came up with, so they don't get sued. If you want to get rich ... you have to concentrate and focus."
> ...
> So looking out for value buys and concentrating on a very small number of stocks seems to me to be reasonably sensible. So far I've managed to make a return of about 20% in six months while testing this strategy, though obviously that is much too short a time period to draw any inferences.




Yes, of course there is truth in it, a lot of truth. You wont get Rich by investing in highly diversified funds; but you will get Comfortable.  For most people thats perfectly good enough and can be achieved with a lot less risk than by running a concentrated portfolio.

But remember diversification is not about numbers of individual shares, its about businesses and location.  If you are going for multinational blue chips, then location becomes irrelevant (currencies etc balance out) and you only need to consider the businesses.  In my view 10 well chosen shares is more than enough diversification. And every portfolio should have a place for one 'risky' share .

Pesonally, I am heavily into Big Oils at present, on the premise that supply and demand must correct itself and this seems to be happening, and paying nice dividends while it does so. Experience is a great teacher and rules are made to be broken, but remember gaining experience in investing can be very expensive.


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## Gordon Gekko (26 Dec 2016)

sunnydonkey said:


> You wont get Rich by investing in highly diversified funds; but you will get Comfortable.
> 
> In my view 10 well chosen shares is more than enough diversification.



I would challenge that assertion. I maximise my pension contributions and it's supplemented by a decent employer contribution. It's invested 100% in diversified global equity funds and the fees are low. 40 years of that will get someone pretty rich.

As I understand it, academic research suggests that one needs a minimum of 30 equities to be diversified.


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## sunnydonkey (26 Dec 2016)

Gordon Gekko said:


> As I understand it, academic research suggests that one needs a minimum of 30 equities to be diversified.



I'd like to see that research.  30 shares is just going to achieve a reversion to mean, giving you an average performance. You might as well buy a fund instead of trying to pick shares.


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## Rory T Gillen (31 Dec 2016)

A terrific book on 'trading' is 'Way of the Turtle'. If you want to trade markets, the book highlights the need for finding an 'edge' on the market and consistently applying that strategy and how difficult that can be. The book is available on the online book stores and it's a great read even if you never intend to trade.


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