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 off: infrastructure assets

When I started this blog, I bought shares in three categories: consumer staples, infrastructure-related companies and online portals. Nowadays, I only entertain the first category. First, I sold off all my tech companies during their wild share price movements in early 2023. The volatility made me realize that I don't fully comprehend what drives the valuations of these tech giants. In the case of Alibaba and Tencent, for example, the Chinese government has a particular interest and involvement, which seems impossible to gauge. In the case of Meta Platforms, there were concerns about the costs of its Metaverse, which I found equally impossible to evaluate.

Mid 2023, I also started selling off my infrastructure-related companies and REITs. These types of stocks are easier to understand than tech. However, another reason to avoid this sector emerged: increasing debt burdens. Hard assets are almost always bought with leverage. I believe that interest rates will be higher for longer. I started by selling off particularly vulnerable companies like Ho Bee Land. Over the months, I grew increasingly uncomfortable with leverage, even for my holdings with relatively strong balance sheets. I scrutinized all my infrastructure-related holdings individually and made the following sell decisions.

Sold: Anhui Expressway Co Ltd (HKSE:00995), Qilu Expressway Company Ltd (HKSE:01576), Jiangsu Expressway Co Ltd (HKSE:00177)

The 'higher interest rates for longer' mantra may not apply to China, at least not for now. These toll road operators are not under immediate debt pressure, but I had other concerns. Chinese toll road operators generally do not disclose their concessions' end date. However, we can compare the total yearly amortization of the concession value with the total remaining concession book value. We then realize the average remaining concession is often only 10 - 15 years. After expiration, the toll road operator has no assets left unless it negotiates renewals for its concessions or gets new concessions. It's hard to gauge whether concessions will be renewed and at what price. Consequently, it's hard to establish a valuation for these operators. It's like a discounted cash flow formula with or without a terminal value. As I argued in the industrial S-REITS article, that means a huge difference in the DCF calculation result.  I find the valuation calculations too uncertain to hold on to these toll road operators. 

Sold: Qingdao Port International Co Ltd (HKSE:06198), China Merchants Port Holdings Co Ltd (HKSE:00144) 

Qingdao Port announced a restructuring of its ports in the form of a combination with sister companies. They issued a 32-page document describing the transactions in legal language. Honestly, I could not get the gist of it. Qingdao Port is a Chinese state-owned enterprise (SOE). The transaction may have some political purpose rather than a business optimization goal. But again, I am puzzled about what was going on in the first place. I found that reason enough to sell. In the same light, I sold off China Merchants, also an SOE with investments outside China that I found hard to justify business-wise.

Sold: Suria Capital Holdings Bhd (XKLS:6521) 

Another port operator, but this time in Malaysia. It is also an SOE, majority-owned by the state of Sabah. The holding contains all ports in Sabah and, as a monopoly, is doing well. However, the growth thesis is based on a large development project next to the port of Kota Kinabalu, which will offer residential and commercial properties. I have no particular insights into the Malaysian real estate sector. Frankly, I should have thought of that before buying the share. Suria Capital has no debt and may be an interesting share for investors who do have detailed insights into the sector.

Sold: China Tower Corp Ltd (HKSE:00788)

Back to mainland China. China Tower Corp is a joint venture of the three leading telecom operators within China: China Mobile, China Telecom, and China Unicom. These three operators sold their telecom towers to China Tower and leased them back. This is a standard construction within the telecom industry, but in this case, all four parties involved are SOEs. The construction makes sense, but there are also opportunities for transfer pricing. If not now, then in the future. It's hard to determine whether your interests as a foreign minority investor will always be considered.

Sold: CK Hutchison Holdings Ltd (HKSE:00001)

Well-known Hong Kong-based holding linked to the Li Ka-shing family. I held the share for over five years, during which its price dropped consistently. Thankfully, my overall loss is limited to only a few per cent, thanks to the high dividend payouts. 

The interest coverage ratio (ICR) of the holding is around 4. The debt burden is not an immediate threat. Still, you could calculate a worse ICR depending on how you account for associate companies' income and debts. CK Hutchison's multiple holdings structure is complex. In any case, however you calculate the ICR, it has been dropping recently. It could fall further, considering CK Hutchison was still borrowing at an average interest rate of only 2.7% until recently. The credit ratings from Fitch and Moody's for Hutchison's debt are still solid, resp A- and A2. Even so, at the moment of selling, CK Hutchison had the highest debt levels among my portfolio companies. 

Sold: Hutchison Port Holdings Trust (SGX:NS8U)

Together with CK Hutchison, I also sold its associate Hutchison Port Holdings Trust (HPHT), a business trust listed in Singapore. Its debt burden is increasing. I calculated an ICR of about 3.7 on 30 June 2023, but a lot of debt has to be re-negotiated soon, which will be at higher rates in the current interest rate environment. Profits will increasingly be re-directed from dividends to interest payments and debt repayments. 

Let me also address the assets' life expiry issue for this trust. HPHT indicates that the concessions for its ports expire from 2038 to 2055. They don't provide the details to calculate a weighted average expiry, but in the case of its Hong Kong ports, it is June 2047. (I assume this date is related to the expiry of the Special Administrative Region status of Hong Kong.) On the other hand, HPHT currently offers a dividend yield of more than 10%. The investor seems sufficiently compensated for the risk that the port concession will not be extended to HPHT. The debt burden, rather than the concession expiries, turned me away from the stock.

The low ROIC of infrastructure stocks

To conclude this blog, an observation about another issue: low return-on-invested-capital (ROIC) yields. Almost all infrastructure-related stocks have low ROIC yields; let's take 4% as an example. This does not immediately seem a big issue when you buy the stock at a price-to-book lower than 1. Infrastructure-related stocks are often quoted at P/B < 1, meaning that the return-on-investment of your recently invested dollar is higher than 4%, for example, in the form of a 10% cash dividend yield, like in the case of HPHT.   

So far, so good, until your new company starts making new investments to either expand into new assets or refurbish existing assets. These new investments are most likely again at the typical low 4% yield for infrastructure and real estate. The free cash flows for the high dividends you enjoyed will be redirected to investments with a 4% ROIC, which you probably do not appreciate. In the long term, your low P/B bargain becomes a trap. I believe this is the mechanism Charlie Munger referred to in the following quote.

Over the long term, it is hard for a stock to earn a much better return than the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you re not going to make much different than a six percent return even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result. So the trick is getting into better businesses. And that involves all of these advantages of scale that you could consider momentum effects. How do you get into these great companies? One method is what I'd call the method of finding them small - get 'em when they're little. For example, buy Wal-Mart when Sam Walton first goes public and so forth. And a lot of people try to do just that. And it's a very beguiling idea. If I were a young man, I might actually go into it.

(Charlie Munger, Poor Charlies Almanack, 3rd Edition, Page 206. "The art of stock picking")

Disclosure: No positions in Alibaba, Tencent, Meta, Anhui Expressway, Ho Bee Land, Qilu Expressway, Jiangsu Expressway, Qingdao Port, China Merchants Port Holdings, Suria Capital, China Tower, China Mobile, China Telecom, China Unicom, CK Hutchison, Hutchison Port Holdings Trust, and Wal-Mart 

Stocks recently bought and sold

Bought: Haleon PLC (LSE:HLN)

Haleon provides over-the-counter consumer healthcare products such as Sensodyne, Centrum, Panadol, Advil, Voltaren, Theraflu, and Otrivin. Such products will always be bought to relieve pain or increase health. The business seems suitable for my Coffee Can approach. Haleon is a spin-off from pharmaceutical company GSK (GlaxoSmithKline), whose current management wants to focus on its prescription medicine business. The IPO of Haleon was in July 2022, so there is no annual report yet. I had to piece my information together from the prospectus, two quarterly reports and analyst call transcripts. While the share price doesn't represent deep value, Haleon is relatively inexpensive.

Bought: Reckitt (LSE:RKT)

This is the company formerly known as Reckitt Benckiser Group. It has a healthcare division comparable to Haleon with health-related products such as Clearasil, Strepsils, and Durex. In addition, they have hygiene-oriented products such as Dettol, Vanish, Air Wick, Calgon, Lysol, and Harpic. Then finally, baby and children's nutrition products Enfamil and Nutramigen. Like Haleon, the demand for these consumer products should be mostly non-cyclical. Reckitt is a much older company than Haleon. Its share price has been going nowhere for years because the company made some expensive mistakes with its acquisitions. The CEO responsible for those has left the company. I expect that the company has learned from these mistakes and will move forward more carefully in the coming years. 

Bought: Haw Par Corporation Limited (SGX:H02)

Another personal healthcare company with only one brand name: Tiger Balm. I use this product myself after visiting the gym. Not so much for 'pain relief' as advertised, but more to emphasise the 'after-glow' feeling following a good workout session. Tiger Balm is trying to expand its product range to plasters, lotions, and even mosquito repellents. Besides the Tiger Balm business, Haw Par runs the Underwater World Pattaya aquarium and owns four commercial properties in Singapore and Malaysia. Its passive investments are a 4.5% share in UOB Bank Singapore, an 8.5% share in UOL, a developer in Singapore, and 600 mln in SGD cash on the balance sheet. If you analyse this collection of assets in detail, you will learn it is organised around the Wee family from Singapore. Family holdings like these are standard in Asia. Such shares will not give you quick profits through share price movements. The thesis rather lies in the safety of the assets and a decent dividend. 

Bought: Tianjin Pharmaceutical Da Ren Tang Group Corporation Limited (SGX:T14)

My final new buy in the consumer healthcare sector is a TCM company. A small position at not even 0.5% because the data I could collect about this business was minimal. The company is based in China. Unfortunately, its English 'Annual Report' is nothing more than the answers to the questions that the Singaporean Exchange provides as a framework for reporting. The answers provide a bare minimum of required data. It is hard to detect any tone of voice or indicator of mood from the management. Da Ren Tang is a 3 billion USD large-cap company, listed in 1997 and providing dividends all that time. Therefore, it is unlikely to be a fraudulent S-Chip. The goal of fraudsters is to collect money, not to distribute it. Finally, Da Ren Tang has no debts and a high ROIC. Its valuation seems decent, even low.

Sold: Okamoto Industries Inc (JPN:5122)

I sold Okamoto, a manufacturer of condoms. This company does not publish financial reports in English. Since I don't master Japanese, I always used Google Translate to gain insight into the views and strategies of the management. I did not get the gist of the limited comments they made. I am unsure whether the Google translations were poor or the words did not have much substance in the first place. While preparing my blog about family-owned companies, I discovered that the Okamoto family only holds 13% of the shares. That seems a relatively small commitment to support the 'skin-in-the-game' argument for family-owned companies. In summary, my conviction in Okamoto disappeared, and I sold it at a slight loss. 

Bought: WH Group Limited (HKSE:0288)

Another share where I only have just enough conviction. WH Group Limited engages in the production, wholesale, and retail sale of meat products in China, the United States, Mexico, and Europe. They have known meat brand names in all these regions. What are the advantages of such a worldwide approach? However, both the business and the share price are stable over time. 

Sold: Yum China Holdings, Inc. (HKSE:9987)

Yum China is the franchise holder for Pizza Hut, KFC, Taco Bell, Lavazza Coffee and a few local restaurant brands for Mainland China. Business is going well, and the share price has soared. When I bought this share, it was already priced high, but it has reached an extreme valuation by now. Just as an indication: the P/E is around 60. It is too optimistic. Let's consider that even when the expected growth occurs, there will be enormous workforce challenges. A restaurant chain does not scale up quickly and will need many workers. I decided to take my profits for now. I have put Yum China back on the watchlist and might purchase it again if it drops to an attractive valuation. 

Partially Sold: Luckin Coffee Inc (OTC:LKNCY)

My Luckin shares had a fantastic run. I bought my position for 9.95 USD per share, and it's nearing 30.00 USD now. Management is solving the issues related to the earlier fraud one by one while simultaneously growing the number of shops at a high pace. Let's hope they can soon re-list the shares on a regular exchange. Despite all the good news, I sold about 40% of my Luckin shares. The current share price represents a total market cap of 7.5 billion USD. The share may have reached a fair value by now. By selling 40% of my holding at almost 300% return, I am locking in my purchase price for the total holding plus some profits. Wherever Luckin's share price goes, I already made an overall profit. I will hold on to the remaining 60% and wait for a re-listing event before I decide on further actions.  

Shares in the most prominent Chinese coffee chain belong in a portfolio called Coffee Can APAC. However, at this stage, I am worried about the over-the-counter status of the stock. I also suspect that the meme-stock crowd is partly responsible for the recent share price rally. Luckin was mentioned on the WSB Reddit. Stocktwits and regular Tweets about Luckin are mostly meme pictures and hollow phrases cheering on the share price without providing any analysis of its fundamentals. That is all fine and well, but such uninformed investor herds can drop a share at a hat's tip again. 

Bought: Oriental Holdings Bhd (KLS:4006)

Oriental Holdings runs dealerships for Honda cars in Malaysia, Singapore and Brunei and for the Mitsubishi brand only in Malaysia. It also holds a 15% stake in the Malaysian assembler and distributor of Honda cars. In addition, it makes plastic products to support car manufacturing. The second most significant activity of Oriental Holdings is owning and managing oil palm plantations in Indonesia and Malaysia. Furthermore, it owns nine hotels which are marketed under the Bayview label. It also built and runs a hospital in Malacca, Malaysia, and trades building materials. Yes, it is a conglomerate entering my portfolio again, violating my checklist a few times. Yet, the long-term vision behind the management's approach gives this share a Coffee Can vibe. Oriental Holdings holds a lot of real estate and land, which seems undervalued on its balance sheet. This will be interesting to explore in future blogs. The stock is locally considered 'sleepy', but occasional announcements prove that the management is actively developing the business. Recently, some plantations co-owned with the Loh family, the majority owner of Oriental Holdings, were sold to the holding, which now has full ownership. This should raise revenues and profits in the short term.  

Sold: Suntec Real Estate Investment Trust (SGX:T82U)

I did some rethinking about my REIT holdings; let's call it REIThinking. Interest rates have been rising recently, which prompted me to look at the debt levels of my current REIT holdings. Suntec has a Gearing Ratio of 43.7%. The Interest Rate Coverage is 2.6, while only 53% of its debt is financed with fixed interest rates. As a side note, I rely on the excellent blog REIT_TIREMENT for financial summaries on all Singaporean REITs. Suntec was the weakest among all my REIT holdings on debt indicators. I don't think Suntec is in distress in any way. Nevertheless, it is my preference to switch to other investments.

Sold: ESR-Logos REIT (SGX:J91U)

A similar story to Suntec. Gearing is 41.8% with an ICR of 2.8. At least, ESR-Logos secured 72% of debts at fixed interest rates. The weighted average debt maturity is 2.9 years. Besides the leverage, I am worried about the involvement of ESR Group Ltd in several of my REIT holdings, as I expressed in an earlier blog. The fundamentals of ESR Group itself do not look rock-solid to me. Of course, it is just the sponsor and manager of my REITs, but with deteriorating financials, there might be an impact on the REITs they own and manage. For my own peace of mind, I will cut some exposure. 

Sold: Sunway REIT (KLS:5176)

Sunway REIT is Malaysian and not covered by REIT-TIREMENT, so I had to go out and collect the relevant data myself. Unfortunately, the leverage picture was not pretty. Gearing 41%, ICR is 2.8, with only 32% of the debt on fixed rates. On a different note, I don't like it when a REIT has one dominant party as its tenant. I recently wrote a new checklist item on that. In this case, that predominant tenant is Sunway Berhad, albeit through different legal entities. Can you really negotiate rents freely with such a dominant tenant? Again, there is no sign of immediate distress concerning this REIT. It's just me following my checklist rules.

Sold: Camellia PLC (LSE:CAM)

As I described earlier, this company violates three of my checklist rules. The business is commodity-based, organised as a conglomerate and primarily located in India and Africa. It is a problematic business sector, and the company needs better management. Lately, they have shown some willingness to dispose of non-core activities. They also vacated its posh headquarters to re-develop it for residential purposes. But it is too little, too late. I sold most of my holdings and will sell the remaining part when I need liquidity for another share purchase.

Sold:  JD.COM (HKSE:9618), Alibaba (HKSE:9988), Tencent (HKSE:0700), Meta Platforms (META)

I sold all my online platform shares, some of them at a considerable loss. I recently concluded that I find it impossible to truly understand these businesses. When I started my Coffee Can portfolio in early 2022, I defined three pillars to distinguish my shareholdings: 1) Consumer Staples 2) Infrastructure 3) Large online platforms. I came up with these buckets because most of my existing shareholdings were within these categories already.  

During 2022, we learnt that political developments strongly impact the profitability of large internet companies. Chinese government interferes in different ways than the US government, but government actions are hard to predict in both countries. Adding to the complexity, we also need to foresee whether the companies remain relevant from a technological and marketing perspective. For example, I read dozens of articles, tweets and blogs on the Metaverse, but I am still unsure whether this will pan out in any usable way. Following online businesses and thinking about the technology sector proved time-consuming and impractical. I opted for simplicity and dropped bucket 3) altogether. I should have a 'too hard' basket if Warren Buffett has one too.

Sold: Sun Art Retail Group Limited (HKSE:6808)

This sell trade is linked to the Alibaba sell-off mentioned above. Alibaba has a majority share in Sun Art Retail. Management is combining the operations of both entities. The share price movements of both listings correlate strongly. There will likely be a take-over offer by Alibaba for Sun Art at some point. I see no particular value in holding on to Sun Art.

Conclusion

As a buy-and-hold investor, I did an awful lot of trading. I chalk this up to the startup hurdles of the Coffee Can project. First, I sold some existing holdings that do not conform to the Coffee Can idea. Later on, I made the strategic decision to drop the technology bucket 3). This resulted in five sell trades as described above. Then I made some improvements to my buy checklist. I added requirements, such as a diversified tenant base for REITs. In addition, I sold off some weaker REITs in response to rising interest rate levels. Then finally, I took some profits with Yum China and Luckin. 

I held 75 shares at some point. I reduced this to 64 holdings, which is still too much to keep track of. I will likely sell some weaker shares to bring the total down. Furthermore, I will keep taking profits when share prices soar to ridiculous levels. Even with these two reasons to trade, I expect to slow my overall trading activity.

Disclosure: I hold Tianjin Pharmaceutical Da Ren Tang Group, Reckitt, Haleon, Luckin Coffee, WH Group, Oriental Holdings and Haw Par Corporation at the time of this writing