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My Thoughts On Portfolio Management Or Don't Be A Turkey

In this short blog post I will layout my rules on portfolio management in regard to the number of positions, position sizing, holding period and when to sell.

On the one hand I agree with Charlie Munger and Warren Buffett that a concentrated portfolio is a good way to generate outsized returns. On the other hand I am a young investor with less than a decade of investment experience.

Therefore I want to minimize my risk of a permanent loss of capital by a) only invest with a big margin of safety and b) limiting the size of each position in my portfolio.

Formulated in another way: I just don't want to be a turkey.

Point a) includes to only:

  1. invest in companies that trade for a discount to fair value of at least 1/2 (upside of 100%+) or companies with an expected return of at least 20%
  2. invest in companies that trade for a discount of 1/3 (upside potential of 50%+) plus a catalyst or companies with an expected return of at least 15% plus a catalyst

Possible catalysts are:

  1. a likely sale, spin off or split of the company
  2. a buyback of at least 5% of the shares outstanding
  3. a significant liquidity event like the expansion of the publicly traded float by at least 50% in the next three years

Point 3 happens a lot to companies taken public by private equity funds.

I use these two valuation methods to be sure of an adequate margin of safety.

Another way I try to minimize risk is by working with 3 scenarios: bear case, base case and bull case. The upside and expected return numbers above are in regard to the base case scenario.

I also write out my idea and wait one week after I have done the analysis to be sure I don't act irrational in the heat of the moment.

On special rule applies to asset plays: I won't get involved unless there is a clear catalyst and the company is free cashflow positive. Negative free cashflow can ruin the entire investment thesis and the possible long waiting period is very expensive, if one takes into account opportunity costs.

In regard to point b), limiting the size of each position at purchase date, over time I want to slowly reduce the number of positions in my portfolio to reduce transaction cost and be able to focus on a few good investments while expanding and deepening my circle of competence. With a deeper circle of competence concentration makes sense and is safe.

In the future I will take the following position sizes:

Valuation

Position size 2017-2020

Position size 2020-2023 Position size 2023-beyond
100% Upside 10% 15% 20%
50% Upside + Catalyst 5% 7,5% 10%

There is one special rule about my position sizing: if I have 100% confidence in my thesis, I allow myself to double the size of the investment. I created this rule by looking at Warren Buffett's investment in American Express after the Salad oil scandal and his comments on portfolio management. This will happen rarely and as of today only one company would be in that category at the right price: Berkshire Hathaway (BRK.A, BRK.B).

Whenever I buy a new investment I do it with the implicit understanding of holding it for a minimum of 3 years. Every year I will do a complete new valuation from the ground up to check my thesis and after every quarter I will check, if my thesis is still valid without a complete new valuation.

I'm going to sell an investment, if:

  1. The investment trades around fair value (+/- 10%)
  2. Opportunity cost -> I found another investment with at least 50% more upside
  3. My thesis is wrong

I hope my thoughts on portfolio management were fun to read and are helpful to you in thinking about your portfolio management.

I would love to hear from you about your approach about portfolio management in the comment section.

Disclosure: I am/we are long BRK.B.