27 October 2022

How I bought 75 shares. And why?

Most value investors recommend holding a concentrated portfolio of stocks in which we have high convictions. Any number higher than 10 or 15 stocks is considered 'diworsification'. Once, Warren Buffett invested 50% of his net worth in GEICO stock. However, I want to avoid such concentrations. I currently hold 75 shares in my portfolio. This is a lot more than most private investors. Starting this blog is an excellent moment to explain why I diversify that widely. I will also detail how I size a stock position.

Reason #1 : I am not Warren Buffett

I have been investing for almost 20 years. My stock picks did reasonably well, but I also observed that my highest conviction buys did not yield the highest returns. I concluded that I shouldn't take my own convictions overly seriously. I am not as experienced as Warren Buffett or Charlie Munger, who make large, concentrated investments.

Reason #2 : I invest in emerging markets

When Asian value investing pioneer Dato' Seri Cheah Cheng Hye started Value Partners Group in 1993 in Hong Kong, he still believed in having a concentrated portfolio. He told everybody they would not find more than 40 companies in his fund. As the years went by, he realised that the Asian market differed from the US. There were a lot of company managers that did not do what they told you they were going to do. There were a lot of crooks. Cheah Cheng Hye told this anecdote at the Graham and Dodd Breakfast Keynote Speech, at Columbia University, New York City in October 2010. Around that time, I started investing in Asian stocks myself. I decided to heed the warning. 

There is a lot of company-specific risk in Asia related to fraud and mismanagement. It seems that Cheah considers 40 companies already too concentrated. Therefore, I decided never to invest more than 1% of my portfolio in any company incorporated in an emerging economy country. In that case, even if a company turns out to be a complete fraud, despite my checking all the red flags before investing, I am bound to lose 1% at most.

My position sizing system

2% + 2% position for a company incorporated in a developed market

0.5% + 0.5% position for a company incorporated in an emerging market

Let me remind you that, as I wrote earlier, I don't trust my own conviction and excitement for a particular stock too much. That's why I made a strict system with fixed, equal allocations per share: 2% extendable to 4% for companies in developed markets and 0.5% extendable to 1% for emerging markets. 

For example, a new buy of a UK-incorporated company share initially gets a 2% allocation within my portfolio. I hold this position for at least a few weeks to get a better feel for the company. If it is again the best possible buy after this probationary period and I have cash available, I double down to a 4% holding. It also happens that something feels amiss during the probationary period, or I actually discover some worrying detail. I noticed that I look more critically at a stock once I own it. So, if my conviction decreases, I just sell the 2% position off again and make a note to never repurchase it.

For emerging markets, such as China, Malaysia, Indonesia and Thailand, I use the same system but 0.5% plus potentially another 0.5% at a double-down occasion, leading to a maximum of 1%. An 0.5% position hardly impacts the total portfolio performance, so I prefer to double down on these positions at some point. This contrasts the 2% positions, which I usually double down on if they genuinely become a deep-value bargain.

With most stocks at 1% or 2% positions, I leave the portfolio alone. Remember, this is a Coffee Can portfolio for the long term. The fundamental principle is not to mess with it. I have a small list of valid reasons to sell a stock, for example, when management changes dramatically, or the things they do are hard to understand. In such cases, I always sell the entire position. 

Just to resume. If you see a 3% position in my portfolio and its headquarters are in a developed country, then it was initially a 2% position that went up. It could also be a 4% position that went down. It is also possible that the currency of that stock went up or down against the USD. The positions in my portfolio overview are sorted on their value in USD. Also, events like dividends in specie and spin-offs over time diffuse my system away from the initial 0.5%, 1%, 2% and 4% positions. These movements are not really a problem because the goal of this system is to force discipline upon the purchase process and not on the holding phase.

Final note: You may argue that 'emerging economy' definition is unclear and debatable. Several organisations keep track of national economies, and their categorisations are summarised in the Wikipedia entry for emerging market. I follow these, in particular the IMF categorisation. Note further that many companies have their headquarters in a jurisdiction where they have none or few operations. For example, many Chinese companies have a registered office in Hong Kong, while their activities are mostly within China. In such cases, I usually assume the risks to be associated with the country where most of the company's operations occur.

17 October 2022

Introducing the Coffee Can portfolio

Coffee Can Portfolio is a metaphor for 'buy and forget' investing. Before the existence of reliable banks in the US, people used to keep their valuables in used coffee cans without touching them for years at end. Financial researcher Rob Kirby discovered that keeping your stocks untouched in your portfolio for extended periods leads to higher performance. He called this strategy the Coffee Can Portfolio. 

Goal: capital preservation, even in the event of hyperinflation.

I only buy within my circle of competence:
  1. Consumer staples ("The Coffee")
  2. Infrastructure ("The Can")
About half of the portfolio is in consumer staple stocks, and the other half is in infrastructure-related stocks. Note that I do define these two categories somewhat loosely:

Infrastructure: telcos, offices, malls, business parks, ports, warehouses, toll roads, industrial and agricultural land. As much as possible in REIT structures. The key is that the invested company is the asset owner or long-term leaseholder, so the assets will function as an inflation hedge. 

Consumer staples: I look for suppliers of food & beverage products, household & personal products, tobacco, and non-prescription medicines catering to the end-consumer. The key is that these companies are the brand name owners of their products. Online retailers, supermarkets, and convenience stores that sell house-branded items are included here too. I also count branded fast-food chains that offer affordable meals. 

Approach: Make many small bets, take each of them serious and maintain a value-investing mindset. Although the intended holding period is forever, I do not literally forget my holdings. I keep track of the significant news events concerning them and occasionally replace poor performers with stronger candidates. I prefer companies where the total debt is smaller than the owner's equity value and where there are positive free cash flows and dividend distributions.

I avoid highly cyclical companies, consumer discretionary, residential and hospitality real estate, momentum plays, meme-stocks, micro-caps, SPACs, short-selling, IPOs, turnarounds, special situations, funds, crypto and other distractions. I generally avoid any investments where I am waiting on some dramatic catalyst, like a super-dividend, take-over or activist involvement. Such catalysts often do not happen; if they do, I have to search for another case to re-invest the proceeds. I prefer to focus on companies where I am happy with the dividends, the revenue growth or both. In short, buy, hold, forget and sleep well at night.

I will add conglomerates only with hesitation. This corporate structure is outdated but still commonly found in Asia. I will consider it only if management is exceptional and most of their revenues are in the two categories above.