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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 improve their chance of outperformance. We were discouraged after our initial analysis because the overall stock selection was basically pure chance (profitable positions for all clients was 51%). The saving grace was position sizing (winners outperformed losers by an average of 20%). The position sizing 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 expected return. Then assume there is a margin of error for forecasts and thus no investor would want to invest in any position that has less than a 15% expected return. If we assume that expected returns are normally distributed and that the standard deviation is 15%, then 68% of equities would fall into the No Invest Zone.

The Benefits of Concentration

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

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