Despite Flo's excitement that headline is misleading.
In posts that talk about stock picking versus all fund portfolios versus some combination of the two, comments get left opining that stock picking is difficult or risky or whatever. So for the fund investor who goes narrower than an SPY, EFA, AGG mix could they spend the time and do the work to own three stocks from themes that were especially compelling to them for which there was no sector or country product?
Sticking with three narrow themes for which I have no exposure, let's say an investor believes Cyprus (oh yeah, there's a stock market there) is the place to be, well for that person there is only one choice (that I know of); The Bank Of Cyprus (BCYPF) and it has been a pretty good proxy for the General Index of Cyprus (YTD the bank is down 28% and the index is down 29% and the charts look identical).
How about shipping stocks? A lot of people seem to like these, the story is clearly compelling (stuff's gotta get there from here) and many of them pay very large dividends. There are quite a few stocks that are in shipping one way or another but no sector fund to own.
Lastly let's say an investor thinks the plane leasing stocks are going to finally turnaround (they have been bludgeoned), there's a handful of these but no fund. Some of them capture the growth in passengers in places like India and if they can get their cash flow squared away they offer the chance for enormous dividends.
To be clear I don't own any of the three, I've tried to learn a little about them and do watch them to varying degrees.
So the question is could a fund investor reasonably learn about two or three or four disparate themes and devote 5% or maybe even 10% of the portfolio to them while putting the rest into some sort of well planned, properly diversified combo of broad-based ETFs or, if they are so inclined, sector funds (properly weighted)?
This is obviously core and explore. As far as risk of individual stocks, let's start with the premise that regardless of anyone's stock picking acumen it not difficult to discern when a stock is a lottery ticket, like a biotech whose only drug is in phase 1 or a mining company that has never actually mined anything. So that pretty much rules out a one day 75% hit to one of the three stocks.
The realistic risk from a bottoms up problem (meaning the wrong stock was selected), as opposed to a top down problem (like you buy a Chinese stock that cuts in half at the same time the market cuts in half), might be from an earnings problem which seems is usually no worse than a 20-25% hit (that is a relatively extreme reaction but of course there has been worse).
Another risk might come from something like losing out on a contract as recently happened to Boeing (BA), although the immediate impact was quite mild.
One last risk that seems to come up a few times lately (to be clear this is in no way an exhaustive list of risks) is some sort of balance sheet/accounting issue which again seems to max out at worse with a 20-25% immediate reaction.
One risk that is not very likely is fraud. If the probability of fraud is low then the probability of owning more than one fraud stock at the same time is incredibly low.
Additionally 2-3% each into three different stocks from different themes can mitigate some of the top down risk (like owning three discretionary stocks late in the cycle). Combine all of that with some sort of stop loss strategy on the three and the risk would seem to come in off the ledge a little bit.
The point of all of this is not that you should go out and buy stocks today. But if the only way into an important theme important is with a stock you should be open to the possibility of buying a stock.
4 comments:
Roger - the largest and in my estimation, best shipper in the world is AP Moller/Marsek. It is sold on the Danish exchange for approx. $8,500 a share USD. Unlike other shipping companies, they have a small yield of 2-3%, but you do not have to worry about lossing 20% of earnings if a ship is dry docked.
The vehicle, for me, is much less important than the asset class or theme that it exploits. The ETF crowd gets wrapped-around the axle over this, using ETF's for the sake of using ETF's, when other vehicles might offer more beneficial features. Is holding EFA, which yields less than 3% and is down 5% over the past 12 months, any better than holding (for example) HBC (9% yield, -7%), TOT (3.7%, +12%) and VOD (4%, +10%)? Hindsight is 20/20, but that is a major bank, a major energy company and a major wireless company - a decent way to play any country or region.
A bit off topic, so maybe you can do a post on it sometime. I worked for an investment genius, the kind of guy you read about - a T.Rowe Price sort of guy - where his genius was in not thinking like anyone else, which is what makes him a complete PIA to work with since he has no manager/people skills - basically what has made him so great is what makes him so terrible to work for.... During this time I went to B school part time and learned what everyone and their brother is taught - MPT. My issue is that what I have learned from the genius is not reconciled with MPT. The simple issue, MPT assumes the world on a bell curve, and we aren’t in a bell curve world anymore. Learning how assets react with each other, and not what actually makes up the asset is what is being taught in schools.... So, my question as a young aspiring money manager, every interview I have gone to, the firms are all about MPT - which I can fake, but I don’t believe in.... So the bottom line - how do you feel about MPT as a whole? The good part of MPT that I can see is it gives mediocre managers a sell and buy discipline...but that is about it. I am not talking about diversification etc., but the specific belief that the way assets interact with each other is more important than the asset themselves. It seems dangerous and lazy to me – buy this because of this number it historically kicks out when compared to this asset…. Maybe this works on the fund of fund level? I don’t know, I feel lost right now. A crisis of financial beliefs if you will. Bashing MPT is not new, and smarter people than myself have found problems with it….
http://www.smartmoney.com/invisiblehand/index.cfm?story=20071120 as just one example.
I like this comment, and thanks Roger for the follow up in your post. I have similar ambivalent feelings towards MPT.
I've come across reflexivity theory while dealing with Soros, and I think it makes a LOT of sense. The whole bell curve criticism is very true. (Taleb makes the point really nicely in his two books.) MPT sounds very textbookish. Manias, panics and greed is what governs the markets.
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