When we build a portfolio, we aim to limit risk. That said, understanding investment means accepting risk as an inevitability, while also confining risk to the areas that each individual client can most tolerate. In order to limit risk to the entire portfolio, we approach investment with an eye toward reasonable diversification. We look to expand the number of risk factors in our portfolio, so no one factor bears too much weight, and we invest across asset classes, over the corporate capital structure and around the globe.
Variety vs Uniformity
We build our portfolios by varying our core positions while, at the same time, avoiding over diversification. Consider, owning 2 stocks eliminates 46% of the risk associated with owning a single stock. Owning 8 stocks eliminates 81% of that same risk. A portfolio of 16 stocks eliminates 93% and 32 stocks eliminate 96% of the single stock risk. From there, however, the benefits of diversification decrease. Eliminating 99% of single-stock risk would require a portfolio of 500 holdings, and at that point, we lose capacity to understand the vulnerability of our core sector allocations.
Ideally, we seek 25-30 positions with an average investment of 3% of the portfolio. Higher conviction and shorter duration ideas receive 4-5% allocations, while our higher volatility and longer duration investments receive between 1.5% and 2.5%. We assert that volatility is risk only because human reaction to volatility is rarely rational. Our approach layers durations in the portfolio, thus lightening risks and disseminating the effects of volatility.