I agree with this, which is why I said I could see scaling in to a position this way. You basically allocate equal investments over a time period and dollar cost average your way in over a range: effectively buying more of the company on a dip. Of course, if your thesis is that it will outperform based on valuation, then you are giving up the performance while you are scaling in.
The idea of having a reserve also is a possibility, but when the asset price dips again, you diminish that reserve. So at what point do you say, “I am going to keep my dry powder available” vs “I’m going to use my dry powder because the investment went the opposite way I expected it to, so now it’s an even better opportunity.” I just find it difficult to reconcile these views in my mind.
This is why I like to work with target allocations and rebalancing, more than an overt “buy on dips” strategy, which feels very “seat of the pants”-ish.
You make some great points bchad, and a lot of this is what separates out alpha producers from the rest. I am not an expert on timing and this is an area I hope to grow a lot in over my career. From what I have seen, almost all of the best investors hold significant dry powder. What is “significant” seems to vary, but you have people like Seth Klarman who might have as much as 50% cash at times and his returns are just fine. I don’t know if there is a set benchmark that is objectively better than anything else, but the recurring theme is “opportunistic.”
That said, clearly timing is everything – there is a well known multi-billion dollar fund called Everest Capital that has managed to blow itself up twice in its 20+ year history, the most recent of which was buying into the “dip” after Lehman collapsed (they were down something close to 50%). Not only did they buy at what was (I would have thought, although hindsight is a bitch) very clearly a global melt down in progress (not a “dip”) but they went all in on the dip. My preference as an investor (and this is easier said than done) is to be very widely diversified, targeting at least 80 stocks on the long side (I don’t have the skill today to do it, but I know several who do it and it can work extremely well). If you miss the dips or generally screw up on even several of the names, you don’t sink your battleship. It sort of blows my mind when people invest in, say, 10 stocks. I’m not saying we would all Peter Lynch out and go for 1,400 stocks, but I love diversification into TARGETED names, which admittedly opens up all kinds of questions about time management, sourcing ideas, the definition of value, etc.
Contrary to what the CFA exams teach, I think a lot of professional money managers, including very successful managers, are seat of the pants-ish. My boss finished almost break even in 2008. The reason? He cut back substantial equity exposure near the peak because Russia was floating some crazy pincipal value of bonds to the market at 5% (I want to say it was close to a trillion in face value). His reasoning was that if all you get for investing in Russia, which is insanely corrupt and risky, is 5%, then we must be near a market top. The analysis was much more in depth than that, but that was his tipping point to cut longs and orient the portfolio more heavily toward shorts. Not exactly allocation-driven, but then again, he’s been doing this for 30 years so he has a pretty good feel for how markets work.
I enjoyed reading this thread. I concluded that I might be pretty stupid.
I’m going to implement the advice such as less stocks if not active enough, more cash reserves and dollar cost/building a position. I’m going to try that with MCP and SCHW so they become 10% each. And I need to spend more time understanding the things I buy.
For NAV, I sold half on friday opening and will sell the rest monday. I felt OSK had strong fundamentals so I figured a merge would happen, not so sure with the new poison pill. I don’t really understand their new strategy either. 6 months seems like such a short time to develop a new engine and then sell 100,000+ units of it. They are already a fairly low profit and gross margin company, so how do these restructuring costs not hurt them? I think its value is $10-20 for the next few months.
For KITD, yes they are trying to get IBM, HP or someone else to buy them. I think its at least 1-2 10-Qs from happening. Its speculation so I need reduce my amount to something I’m comfortable with losing.
What do you think about investing in a diversified portfolio of *targeted* names, and shorting the underlying index, while holding a cash portfolio in lieu of a long only strategy? In theory we’d eliminate both systematic risk by shorting the index as well as dramatically reducing security-specific risk by diversification…
What do you mean cash portfolio? You mean just holding cash?
In theory what you are talking (if I understand) about could make sense (long specific names expected to out perform, short the index) but I mostly invest in smaller names, so you would have to try to short the Russell 2000 I suppose for that to even make sense. I don’t know if that would introduce any additional complications, but my impression is that is a very large universe and may not provide a strong hedge (the 1500 smallest stocks will likely get whacked more severely than the S&P 500 during any pull back, which may disrupt the hedge if you are primarily long small cap stocks as well).
I’ve never really considered shorting the index. What I didn’t mention in my above post, but what is critical to the model, is being short a good number of names as well – you might target 80-100 longs and 50 shorts, for example. That doesn’t perfectly remove systematic risk, but it does provide a hedge. If you are good at selecting both longs and shorts, you basically get paid through a secondary source of alpha to take out an insurance policy on your portfolio in the event of a market sell off (not least of which because the names you are short are more likely to be hot money type stocks where momentum investors will be first through the exit during any sign of trouble).
A valid criticism would be for someone to say, “Who picks 150 stocks – can you even find that many mispriced shorts and longs?” The answer to that is yes if you have sufficient skill. I personally know several people (all schooled under the same teacher) that use that model, and all of them have crushed the index over time (decade plus), including 2008 when most of them were near break even. I don’t have that skill yet, but even after a few years of doing this, I can already have a pretty clear picture of which direction a stock will most likely go (most stocks, at least) over the next 3 years in as little as one or two days of research. For most stocks, it simply does not make sense to spend weeks and weeks researching (or even one week) becuase the marginal returns on new information are so low. I don’t need to be the smartest person in the room on every stock I own as long as I am directionally correct with a reasonable margin of safety in the business model, valuation and quality of management.
Interesting, so you always have zero directional exposure? If so, how do you decide how much to allocate to the “portable alpha” part and to the “portable beta” part?
Bromion - when you look for shorts, do you simply look for overvalued momentum stocks or do you look for things like fraud? I’m definitely interested in studying how to make short positions, but the worry is shorting a hot overvalued stock and getting killed…
palantir, i will assume you’re not working with a 1 million dollar + portfolio…so my question is, why not just put more money behind your best ideas? you have had some good ones…so why diversify?
Ha…just looking to get every possible edge I can. Other reason is, there is oftentimes a lull between good idea, like “writers block”, so I need some ideas to keep me occupied to make sure I don’t start buying up random crazy ideas.
That’s a lot of individual names to keep track of, I wouldn’t have enough time keeping up with quartery financials, 8ks, press releases and all that. I’m a firm believer in indexing, but it seems like the possibilty of one stock/few stocks wiping out most of your portfolio is almost nil.