Page 27 - DIY Investor Magazine Issue 24

HOW TO ACHIEVE DIVERSIFICATION?
I avoid having too much exposure to any one sector;
I generally try to own the best business in a sector
and shun the rest. However, focusing on sector alone isn’t enough and can often give a false sense of diversification; you also need to consider any overlap in terms of customers, geographies, industries served and ensure that each holding offers something different.
For example if you own a pub group, a restaurant chain and a traditional retailer, you’re not only concentrating your bets on UK consumer spending, but on High Street footfall - a very narrow remit, and unlikely to pay off.
By the same token, if you owned Barclays, Persimmon and Purple Bricks you’d be invested in three different sectors (banks, house building and estate agency) but in the same theme that will all suffer from a decline in house prices.
The same can be true in industrials where companies offering a wide range of seemingly unconnected products are actually all plays on oil and gas prices. The corona virus crisis will inevitably cause investors to think even harder about how well diversified they are; consumer-facing businesses that rely on people stepping outside their homes have been hit particularly hard.
COVID-19 was a bolt out of the blue, but prudent portfolio construction as a matter of course blends consumer businesses with those supplying goods or services to other companies.
The crisis has prompted me to think harder about how many of the companies I own provide truly essential goods or services, as opposed to serving more discretionary pursuits.
‘HOWEVER, FOCUSING ON SECTOR ALONE ISN’T ENOUGH AND CAN OFTEN GIVE A FALSE SENSE OF DIVERSIFICATION’
A PERSONAL JOURNEY
I started by saying that portfolio construction is a very personal thing, and it has taken me a number of years to come up with a method that I am comfortable with and that is replicable; it doesn’t mean having exposure to every sector or theme, you have to choose your bets carefully.
I have specifically avoided talking about individual companies because these basic principles can be applied across any sector or theme; the more companies I investigate, the more I can identify common threads, but also the points of difference that make some companies exceptional.
I have become adept at identifying companies that fit my method and objectives, and adding those that do not, just because of the assumed diversification benefits, is not something that I do.
Investors often come up with complicated dependencies to explain why they hold certain stocks with the overriding principle of diversification; ‘if interest rates do A, B will happen which will benefit C’.
I prefer to focus on key aspects such as the quality of
a company’s business model; in my experience the pursuit of diversification for diversification’s sake leads to compromising other aspects of the investment case and can introduce unintended risks into a portfolio.
Constructing a successful equity portfolio doesn’t need to be complicated; own a small collection of great businesses and make sure each offers something different.
It’s fine to have three or four broad themes to a portfolio as long as they are played via different customer groups, industries, geographies and so on, rather than concentrating too narrowly.
I’ll not pretend that I’m not sitting on some chunky paper losses just now, but for me investing is absolutely for the long term; the factors that motivated me to buy particular companies remain strong so I’ll wait for things to get better as they inevitably will. Stay safe, Hannah.
27 DIY Investor Magazine | Apr 2020