Page 32 - DIY Magazine June 2018

DIVERSIFICATION - HOW MANY STOCKS SHOULD I HOLD?
Matt Bird is a financial adviser who specialises in pensions, investments, mortgages and protection.
He has a keen interest in all things financial and has been an active DIY investor for many years, researching his own share selections and writing a blog on investment-related topics.
Modern Portfolio Theory (Harry Markowitz 1952 – not that modern) suggests that portfolio diversification could ‘reduce risk and increase returns for investors.’
The conclusion is that a diversified portfolio of imperfectly correlated stocks reduces the overall risk to less than the average risk of the individual securities. The downside risk of one investment would be offset by the upside potential of another investment.
Unsystematic risk (i.e. the risk of a particular company performing badly), can largely be eliminated by holding a diversified portfolio. (NB Systematic risk – the risk of
a general market fall – cannot be protected against by diversifying within the same asset class i.e. stocks) Various academic studies suggest that 15 to 20 securities selected at random are sufficient to eliminate most investment-specific risk in a portfolio, however the more securities are added, the more the risk diminishes. (source – Investment Principles and Risk Textbook – CII) I wholeheartedly agree with the premise that holding more stocks does help to protect against the unknown ‘black swan’ events that can come out of the blue and smash a company’s share price into smithereens, but does holding too many stocks throttle performance by diluting one’s best ideas?
In consideration of this, firstly I’d like to dwell on some personal experience.
Although I have dabbled with shares since the late 90s, my first serious stock pick was in 2009. I’d held a FTSE All Share tracker fund (obviously reasonably diversified) since 2005. I watched it rise for a couple of years, and then subsequently crash monumentally when the Credit Crisis hit. During that crash I decided to take a more active approach and disinvested the tracker fund to buy a handful of stocks that I perceived to be trading at significant discount to their intrinsic value. Luckily one of those stock picks was Barclays. I bought into them in the early spring of 2009, and subsequently sold in the autumn making over 200% profit.
Because this holding represented a relatively large portion of my portfolio, this pushed my total returns for the year to 75% which to date has been my best year in terms of percentage gain.
As time has progressed, the number of my portfolio constituents has grown steadily, and now it stands at 32 individual companies, 4 investment trusts and 11 OEIC/ Unit Trusts (which I evaluate separately.) Excluding the Unit Trusts, which have been a relatively recent addition, my average annual return (after all trading fees but including dividends reinvested) over the 9 years from 2009 to 2017 has been 16.95%. Although when you strip out that great year in 2009 my average annual performance falls dramatically to 11.2%. The All Share Total Return index also had a decent year in 2009 delivering 30.12%. It’s annualised return over the last 9 years has been 11.23% which falls to 9.1% per annum with 2009 stripped out.
To summarise, my personal experience thus far has been that higher returns were generated with a more concentrated portfolio, albeit this experience is heavily skewed by good fortune in one particular stock pick, during a particularly good year to be stock picking.
If Barclays had gone to the wall during the crisis my results would look remarkably different. With this in mind, going forward would I be better off ditching some of my holdings and using a more concentrated approach?
Most money managers with great track records appear to agree that a more concentrated portfolio is beneficial for delivering higher returns. Even Peter Lynch, the US fund manager who averaged an annualised 29.2% during his tenure at the Fidelity Magellan fund, which towards the end of his reign held as many as 1400
HOLDING MORE STOCKS DOES HELP TO PROTECT AGAINST THE UNKNOWN ‘BLACK SWAN’ EVENTS THAT CAN COME OUT OF THE BLUE
DIY Investor Magazine | Jun 2018 32