Concentration is better than diversification

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.

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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.

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.

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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.

Duke of Marmalade said:

Take the Aberdeen UK Tracker Trust

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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.

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.

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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.

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.

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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.

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."
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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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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.

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.

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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.

Gordon Gekko said:

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

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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.

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.