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The Concentration Manifesto

Highlights

Empirical Proofs

We have spent the last year analyzing client data, trying to discover ways for clients to improvetheir chance of outperformance. We were discouraged after our initial analysis because overallstock selection was basically pure chance (profitable positions for all clients was 51%). The savinggrace was position sizing (winners outperformed losers by an average of 20%). The positionsizing benefit allowed our clients to dramatically outperform their peers:

Great Ideas Are Hard To Find

Assume that no investor wants to invest in a position that does not have a positive expectedreturn. Then assume there is a margin of error for forecasts and thus no investor would want toinvest in any position that has less than a 15% expected return. If we assume that expectedreturns are normally distributed and that the standard deviation is 15%, then 68% of equitieswould fall into the No Invest Zone.

The Benefits of Concentration

Our clients experienced a greater than 54% batting average for the top 20 positions, suggestingthat our clients are “good” stock pickers. Said another way, the stocks that our clients are mostconfident in, make money more times than not. Their mistake seems to be investing in lowerconviction, small positions.

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