I really like the tweet @callawoodposted in ‘Quotes of the Day’ from Ian Cassel. I thought it deserved to be reposted here under portfolio management:

tweet

“If you are fully invested and have a finite amount of capital like most human beings - When you evaluate new opportunities, you are constantly evaluating them against what you already own. A new opportunity can’t have similar upside to an existing position, it needs to have considerably more upside to replace the “trust” in what you already own. There is a time value in accumulating knowledge on a position. Often times the best opportunities are already in your portfolio. You don’t want to dilute your returns. But once a year or so you’ll find something new that is really good - that forces you to sell your least convicted position. It’s a time for celebration. You finally found a player that makes the team better.”

This is exactly how I think about our portfolio. I keep a spreadsheet with all the businesses we own and others I am watching. I update the expected rate of returns for each of these businesses at the current share price (based on valuation). If I find a businesses that has the potential to outperform any in our portfolio I will add some shares. As I do further research and my conviction grows in the ‘new’ businesses I will add some more. To fund the purchase of the ‘new’ business I will use either dividends or sale proceeds from the business in our portfolio which is likely to be the worst performer.

Eventually, by following this ‘best team’ strategy and limiting your portfolio to 25 to 30 of the best performing businesses, the quality of your portfolio should continue to improve each year. There are 4 businesses on my spreadsheet that I believe have the potential to return over 20% per year, 16 that have the potential to return over 15% per year, and 35 businesses that have the potential to return over 14% per year. Why would I hold any more businesses than that if I need to keep going down the list of lower rates of return just for the sake of some diversification? It very quickly starts to become ‘Diworsification’.

At least that’s the theory behind it. This approach assumes you know what you are doing (which is debatable) and that everything else you are assuming about each businesses and the economy remains the same. It sounds sooo simple! If only it were! :)

Further to my post on Portfolio Management, the boys at Baby Giants including the Strawman himself have had an interesting discussion at my request. Some great commentary and lots of great insights into how they reconcile their thoughts in this complicated area.

Thanks Matt, Andrew, Claude and Kev.

Portfolio management about 25mins in.

https://www.babygiants.com.au/1870616/11793141-56-city-chic-collins-food-beamtree-objective-corp-pro-medicus-portfolio-position-sizing-ed-thorp-protests-in-china-elon-vs-the-app-store

Thanks for your great responses @Greenblatt, @Strawman & @Solvetheriddle some interesting points in there to consider.

As I suspected, a discussion on portfolio management will bring many differing perspectives.

I love the discussion as you can cherry pick the parts and points you can relate to so thanks again for your contribution.

It's an area I'll continue to reflect on and attempt to improve on and hopefully be a better investor for it.

Ultimately, I think you have to be comfortable with the fact you aren't going to get this right most of the time just as long as you are heading in the right direction.

I think Morgan Housel has it right, you need to learn to "live with your future regret" and the rest of it will take care of itself.

@UncleWally big big area of discussion

Portfolio construction is an interesting question but one that does not have and easy answer. also by definition is highly customised, imo. As far as I can see there are two main issues involved. Firstly, taking a broad view the first question is how large is your portfolio is as a percentage of your total wealth? Without knowing this any sensible portfolio construction recommendation cannot be made and it is dangerous for anyone to do that without knowing the proportion of the wealth at risk, in my humble opinion.

For example, if a person has large number of large assets outside of their “portfolio” they can take more risk in their portfolio. If their portfolio is only 1% of their total wealth they can take huge positions. If it is almost all their wealth (like me) the positioning should be much smaller.

I find it amusing and misleading when people talk about their “portfolios” without us knowing exactly how large they are compared to their total wealth. For example, when they say they have gone to 100% cash, what does it actually mean in terms of their total wealth? Knowing this is vital to make sense of going 100% cash but of course it is not any of my business.

The second main area is of course risk. one thing that is become abundantly clear to me after reading many retail sites on investing is just how just how wide the (mis) understanding and interpretation of risk actually is. It is so wide that is almost impossible to compare one person to another.

To me, it relates to how much you are willing to entertain the prospect of permanent capital loss on your investments. This is partly tied to the expose your portfolio has compared to your total wealth and personal preference. Therefore there are immeasurable number of approaches, ranging from those who are looking for a huge return with only a small percentage of their net wealth exposed to the market, to those who want a steady and reasonable return from a large percentage of their wealth, as well as all those in between.

Personally, I have a vast majority of my net worth in the market or in cash waiting to go into the market. Exposure to well-known (by me) and highly profitable companies I have a tolerance of about 2 to 3% of my total wealth. Highly speculate positions could be under half a percent of my total wealth. I also attempt to actively manage positions around a core based on valuations, which can be value accretive if done with discipline and structure, also some skill is a help.

There are some big issues here that could form the basis of a couple of theses, I've touched on a few hope this is of some help.