Concentrated portfolio?

Or comfortable making large bets?

I admire concentrated investors. For some reason, I have this romantic notion that this is the “correct” way to invest. Perform deep research on a handful of companies - perhaps 5, not more than 10 companies - and put significant percentages of your portfolio in each. Then, ride or die with the few companies that make up your portfolio.

Alas, this is not me.

I discovered that this approach doesn’t work with my personality or situation. My investing style has evolved, so I will never say never. Currently, I don’t practice what I consider a concentrated style. I hold almost 30 stocks in my portfolio, probably 15 or more of which are 2-3% positions. Certainly, I hold less than the S&P 500, but most investors would not consider this particularly concentrated.

This hasn’t always been the case. In the past I held positions as large as 45% of my portfolio. Having a holding that large taught me that I was not a concentrated investor. That particular position declined about 30% in a short period of time due to a “not great” quarterly earnings report. Losing 15% of my portfolio in a week showed me the limits of my “drawdown tolerance.” Interestingly, one of the reasons that I dislike such concentrated positions is that I feel uncomfortable adding more to a large position that drops. At smaller concentrations, I’m less emotional, and if adding on the dip is appropriate, I’m able to rationally make that decision. With large positions, it is hard for me to be rational.

Counterintuitively, this does not inhibit my ability to make large bets. For example, I currently have two positions at almost 10% of my portfolio at cost. Both of these positions have similar characteristics:

• They have limited downsides: high cash balances and/or good cash flow and very low or non-existent debt.

• I owned them for a long time and feel like I understand their businesses and long-term strategy.

• They both have made good business progress over the last several years, but their stock prices have not followed this progress. They are either flat or down slightly over the last two years.

• They both have near-term catalysts or business developments that could help the stock re-rate.

I’m hopeful that this approach represents prudent diversification with the upside of making larger, high-conviction bets. If it works as planned, I should still get some concentration benefits with my large, infrequent bets while limiting the downside with diversification.

I’m curious to know how others handle things. What tradeoffs do you make between concentration and risk control?

Is he thinking about risk vs. reward?