Page 26 - DIY Investor Magazine Issue 24

DIY INVESTING: HOW TO CONSTRUCT AN EQUITY PORTFOLIO
Portfolio construction gets less attention than picking stocks, but it can have a profound effect on the risk you are exposed to and the returns you achieve – writes DIY investor Hannah Barnaby
However good a stock picker you are, if you don’t allocate effectively you’re probably not going to do very well and you may also expose yourself to hidden risks. Portfolio construction is a very personal thing full of conflicts; minimise risk, maximise returns, diversify, but not overly so.
It’s a balancing act, and there is no ‘right’ way, it depends upon your attitude to risk and investment style - finding what works for you; here are some of the things I consider when constructing and managing my portfolio.
‘IF YOU DON’T ALLOCATE MONIES EFFECTIVELY YOU’RE PROBABLY NOT GOING TO DO VERY WELL’
HOW MANY STOCKS TO HOLD?
Phil Fisher, US investor and author of ‘Common Stocks and Uncommon Profits’ said ‘it’s better to own a few great businesses than a great many mediocre ones’ and I agree.
Great businesses are rare, well managed great businesses even rarer; I don’t want to add mediocre companies for the sake of it and increase my risk; I prefer a portfolio of between 20-30 holdings for a few reasons:
I like to fully understand the companies I own, and there are only so many I can develop a deep understanding of; most of the best investors I know have concentrated portfolios.
Taking fewer positions forces you to take tough decisions; do I understand this business well enough? Would I be better off holding that company instead?
‘IT’S BETTER TO OWN A FEW GREAT BUSINESSES THAN A GREAT MANY MEDIOCRE ONES’
This approach really allows me to focus in on the companies I own; studies show that beyond about 30 holdings, the benefits for diversifying risk by adding positions is minimal..
‘UNLIKE SOME INVESTORS I DO NOT REGULARLY RE- BALANCE TO KEEP WEIGHTINGS FIXED’
HOW MUCH TO ALLOCATE TO EACH HOLDING?
When it comes to deciding on the sizing of my positions I focus first on risk rather than potential returns when determining my biggest positions.
The bulk of my portfolio consists of lower risk businesses that provide essential goods or services, with repeat
or recurring revenue that are relatively simple to understand.
I take smaller positions in companies I deem more risky, either because they have obvious sensitivity to changes in the economy or because there is a part of their business that I understand less well.
Holdings change relative to one another over time, but unlike some investors I do not regularly re-balance to keep weightings fixed; constant tinkering by pruning winners and topping up losers leads to higher trading costs with no guarantee of better returns.
I let my winners run, and if a holding performs well it earns itself a bigger position in the portfolio.
I prefer to spend my time better understanding businesses than trying to time buying and selling decisions which, like most investors, I’m not very good at. Most investors will have made a decision to sell a holding because we thought it had run out of puff, only to watch it then double in price; if a stock is performing well or badly there is usually good reason, so I try to keep trading activity to a minimum.
DIY Investor Magazine | Apr 2020 26