My position sizing system

• 5% initial position for a company incorporated in a developed market
• 2% initial position for a company incorporated in an emerging market

My old position sizing system was a two percent initial buy plus an additional two percent later for companies incorporated in a developed market. I usually did this second buy after a few months of holding the first portion. The purpose of this lag was to get comfortable with the company in the meantime. Sometimes, I did not get such comfort and sold the share. Similarly, I bought half percent positions plus a half percent later on in emerging market companies. It was a careful start because I started a whole new portfolio. However, I ended up holding 75 shares. There is no way to follow 75 companies as a part-time private investor. 

There is a lot of research addressing the proper diversification of a stock portfolio. I believe the picture below illustrates somewhat of a consensus conclusion.

We can see that a portfolio with only one stock results in a huge standard deviation of its annual returns. Adding one stock reduces this standard deviation considerably. Assuming that the added stocks are equally weighted, the variability of the total portfolio goes down as we add more stocks. At some point, let's say at 25 stocks where the arrow is placed in the graph, adding stocks does not reduce variability in any significant way. 

The graph is compiled by looking at a large number of portfolios. We are looking at reality, not a theory. Nevertheless, this perspective on diversification is debated. Many value investors argue that variability does not represent risk; only permanent loss of capital does. The number of shares does not matter either, but rather how confident you are about the business prospects of the underlying companies after intense research. Charlie Munger was not afraid to hold only three shares. However, I do not have the quality of information, insight, experience, and advisors that Charlie Munger had access to. For now, I will go with the traditional concept of risk as expressed by the diversification graph above. 

In any case, I was severely over-diversified, holding 75 shares. It will be nearly impossible to beat an index fund with so many shares. I already experienced that a very successful 0.5% position, such as my triple return with Luckin Coffee, will barely affect my overall portfolio performance. I concluded that my 1% positions in emerging markets China, Thailand, Malaysia and Indonesia did not make sense. I decided to take 5% positions in Malaysian companies from now on. For China, Thailand, Indonesia, and other emerging markets I will allocate 2% per company. That is still a small allocation, but I currently do not have the confidence to take a 5% position per company in these markets.

The reorganization

After deciding on my new position sizing rules, it was time to take action. I sold off a bunch of shares where I did not have the conviction to top them up to 5% or to 2% for a range of different reasons. This was a useful exercise in itself. I increased the allocations of all the remaining holdings, except for Greggs, ABF, Reckitt and Haleon, which already got too expensive. In the case of turn-around situation LG H&H, I want to wait for the Q4 2023 results. With the reorganization mostly done, I own 25 shares now. 

Further concentration?

Looking at the chart above, I could reduce my 25 positions further to 10 positions. The variability of the portfolio as a whole would not increase that much. I could start with taking 5% positions to 10% where I feel confident that a company is extremely undervalued, such as Boustead Singapore and Ibersol. However, from my past experiences as an investor, I have learned that my ex-ante level of confidence is often misplaced and irrelevant. There is no correlation between my level of confidence in a share pick and the subsequent performance of that share. 

As an example, my current best performers are Exotic Food PCL, Tianjin Pharmaceutical Da Ren Tang Group Corp Ltd and Associated British Foods PLC. I would never have guessed these picks as being my winners two years ago. I would probably have guessed Alibaba or Tencent then. Without a mechanical allocation system, I would have doubled down on these two stocks. This doubling-down behaviour is known as Get‐Evenitis or, more officially, loss-aversion bias. A mechanical sizing system is an antidote to this bias. It saved me from a bigger disaster in the Chinese tech space. 

Hence, I will stick to my mechanical allocation system. Should I ever change the current 5% and 2% sizing numbers, it will be wise to apply the new rules to all my shares, not to a selection.  

Disclosure: long position in all the shares mentioned, except Alibaba, Tencent, Tianjin Pharmaceutical Da Ren Tang Group Corp Ltd and Luckin Coffee, which I sold off

Sold out: post-fraud, triple bagger Luckin Coffee Inc ADR (OTC:LKNCY)

Bought 31 May 2022 at 10 USD

Sold 40% on 6 Febr 2023 at 27 USD 

Sold 60% on 16 Nov 2023 at 31.40 USD

At the time of my buy, the insiders responsible for doctoring the fraudulent sales figures were already identified, removed from the management team and in negotiations to sell their shares. Luckin was involved in several legal procedures to settle damages with early investors, who were disadvantaged by the stock price collapse after the fraud was exposed. To be frank, I have no legal background and did not fully understand all the procedures and documents involved. Every time a case was settled, another procedure was revealed, or some new legal milestone was mentioned. 

Yet, I could sense that a clean-up operation was ongoing, driven by the Chinese fund Centurium Capital, which also became the majority shareholder. Unfortunately, Centurium prefers to operate behind the scenes; there was (and still is) little information available about Centurium Capital and its intentions. The rapid development of the Luckin coffee business itself was much easier to observe. Although I do not speak Chinese, I was able to collect information about Luckin and its successes from online sources like Baidu Maps, YouTube clips, social media reviews and news articles. 

From the incomplete information and my anecdotal impressions, I concluded that the company was genuinely working on its come-back as a legitimate company. In addition to that, the coffee shop network was clearly growing at a fast pace. I decided to buy the share, which seemed cheap at 10 USD. Considering the risk that I was wrong and fraud was still ongoing, I limited the Luckin holding to a few percent of my total portfolio. Still anxious about fraud risks, I sold 40% on 6 Febr 2023 at 27 USD, which meant I secured the return of my initial investment.

I held my remaining Luckin shares for 1.5 years, during which my trust in Luckin's legitimacy increased. Two extensive research reports, Quo Vadis Capital, Inc. and Snow Lake, both recommending a buy, solidified my conviction. In May 2023, I visited the three Luckin outlets that were opened in Singapore at that point. I am not crazy about Luckin's signature coconut latte, but I enjoyed its Americano, brewed of beans from the Yirgacheffe, Ethiopia region. It is a lot better than Starbucks' Americano. (Which is not a high threshold, to be fair). However, neither Luckin's coffee nor the shop experience is exceptional in any way.

I sold out my remaining holdings last week. I noticed that some company insiders are selling their Luckin shares at an increasing scale and pace. 

Especially the selling done by Mr. Reinout Hendrik Schakel gave me pause for thought. In 2019, Luckin hired Schakel as CFO to manage the NASDAQ listing. During the recent Q3 2023 financial results presentation, Schakel announced that he will depart from the company at the end of 2023 for personal reasons. I have two concerns with this development:

1. Schakel's departure could be a sign that Luckin is not planning a relisting from the OTC market back to NASDAQ (or any other official market for that matter). It looks like Schakel concluded that, as the financial markets guy, he has no role left at Luckin. Or, to invert this observation, it would be very strange if Schakel left just before the company finally gets listed again.
2. Besides leaving the company, Schakel sold all his shares. As an insider with a corporate finance background, Schakel is obviously in a better position to value the Luckin stock than me. It looks like he believes that the share is currently overvalued. It also looks like he is not expecting any take-out offer on the shares from Centurium Capital. 

I usually avoid holding stocks in unregulated or lightly regulated markets like OTC. In Luckin's case, I was holding out for a relisting to an official market. After losing my confidence that this will happen any time soon, I see no other catalysts worthwhile waiting for. 

As in the case of my buy, I also made my sell on the basis of impressions and incomplete information. Luckin does not communicate any details besides the bare minimum required. There is just not enough information to go on. 

I applaud the current management team for running one of the fastest-growing businesses in the world. Luckin generates a lot of positive press with innovative marketing actions. Its customers love it. Should the company relist at an official exchange, I might be interested in buying the shares again. 

Disclosure: no positions in Luckin Coffee or Starbucks at the time of publishing this blog