On Running A Concentrated Portfolio

by: Charles Lewis Sizemore, CFA

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I tend to run a fairly concentrated portfolio at Sizemore Capital. My Dividend Growth portfolio - which is an income-focused long-only strategy - will generally have between 20 and 30 stocks at any given time.

There is no particular "science" that goes into this number. It isn't a magic number, and I haven't run studies to optimize it. But in my experience, 20-30 stocks is the sweet spot for me. It's concentrated enough to allow for my favorite stocks to really have an impact on portfolio returns. But it's diversified, so if a single stock has an unexpected blow-up on me, it won't sink the portfolio.

I can also watch 20-30 stocks like a hawk. But that gets a lot harder at higher numbers. I couldn't do in-depth research on a portfolio of 50 stocks, let alone 100. And frankly, once a portfolio gets that big, your best ideas get diluted to the point that you're essentially a closet indexer.

I have no place for closet indexers. It's not to say that I don't see a place for index funds. I most certainly do. But a client doesn't need to be paying active manager fees - which can be 1%-2% for long portfolios and the dreaded 2% of assets and 20% of profits charged by most hedge funds - for something that can be had at Vanguard for a fee of 0.09% per year.

When you let the number of positions in your portfolio expand, quality will inevitably start to suffer. If you have 100 "best" ideas, then they really aren't your best ideas.

Of course, the downside to running a concentrated portfolio is that, when things don't go your way, you can really underperform the market. Now, I could get into a much longer conversation about benchmarks, how they are misused, and why it's a mistake to compare every portfolio to the S&P 500. But the fact is, if the market is up, even by a modest amount, and your portfolio loses money due to your concentrated investments not performing as expected, you're going to have angry clients.

Some will leave you. Others will simply voice their displeasure loudly and often. Some may do both. I had a little of all three this past January, and I understand. Losing money - even a modest amount - is scary.

This is where communication comes into play. Your clients need to understand what it is you're doing and they need to share your basic outlook. They are a lot more likely to be forgiving when trades go awry if they understood your investment thesis going into it.

And that's important. Because when your strategy recovers and has a winning year, you want your clients to participate in the growth. If they lose faith and leave before your strategy rebounds, then both of you lose.

And if you're not comfortable running a concentrated portfolio?

Then you're not very good at your job, you have no business running money professionally, and you should return your clients' fees and refer them to a low-cost index fund.

Note: There is one exception I would make here. If you're running a "smart beta" quantitative strategy, then by all means, 50-100 stocks might be completely appropriate. But at the risk of splitting hairs, you're not an "active" manager at that point but rather a sophisticated indexer looking to build a better mouse trap.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas.

Photo credit: Michael Dales

This article first appeared on Sizemore Insights as On Running a Concentrated Portfolio.

Disclaimer: This article is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results.