Investing is the discipline of “relative selection” 

Conventional wisdom dictates that diversified portfolios are “less risky” than concentrated portfolios. I tend to believe the inverse is true: Over-diversification leads to allocating capital to second or third-rate ideas, which introduces significant risk into the portfolio. The desire for diversification can also lead investors to sell their winners too soon, simply because asset appreciation in those positions can lead to large relative weightings. Concentration certainly leads to more volatility, but volatility has nothing to do with risk. Anyway, Howard Marks discusses some of these concepts in much more eloquent detail in one of his recent ever-insightful periodic memos. The central thesis to his piece grapples with Sidney Cottle’s definition of investing, which Cottle calls “the discipline of relative selection.” 

“Selling an asset is a decision that must not be considered in isolation. Cottle’s concept of ‘relative selection’ highlights the fact that every sale results in proceeds. What will you do with them? Do you have something in mind that you think might produce a superior return? What might you miss by switching to the new investment? And what will you give up if you continue to hold the asset in your portfolio rather than making the change? Or perhaps you don’t plan to reinvest the proceeds. In that case, what’s the likelihood that holding the proceeds in cash will make you better off than you would have been if you had held onto the thing you sold? Questions like these relate to the concept of ‘opportunity cost,’ one of the most important ideas in financial decision-making.”


“The bottoms up fundamental investor is basically irrelevant in… the daily movement of stock prices”

On the latest podcast with Patrick O’Shaughnessy, Ricky Sandler, CIO of Eminence Capital, discusses the pure randomness of stock price movements in the short-term. (As an aside, listening to Randy, I was reminded of one of my favorite Nassim Taleb lines about anyone that claims to be able to time the markets: “If you hear a ‘prominent’ economist using the word ‘equilibrium,’ or ‘normal distribution,’ do not argue with him; just ignore him, or try to put a rat down his shirt.'”) In the podcast, Ricky makes the observation that this short-term volatility is actually quite good for stock pickers: It creates mispricing opportunities that can be exploited by  long-term investors who have a solid variant viewpoint. “Don’t think the market is smarter than you if you’ve done your work,” he says. “The market is giving you less and less signals today than it ever has.” (H/T Josh Tarasoff)

“Random makes it sound even worse… I mean, there’s just big, big players out there that are not bottoms up fundamental investors. So that has created all this mispricing. And for a longer term investor on the long side, this should be purely positive. Why is that? Well, if I think the stock’s going to go from 10 to 20 and it goes to six first, I have less risk on the table. I can buy more. If I did my work, it’s easy to buy more and you end up with more alpha if it ends up at 20. If I think it’s going from 10 to 20 and it goes to 17 in two months, it’s a bigger position. I can sell it naturally. I can turn my capital and use the volatility to my advantage.”


Disrupting the hedge fund model — a chat with the Good Soil guys

I recently had the chance to chat with Emmet Peppers, founder and portfolio manager of Good Soil Investment Management, and his managing partner Matt Smith, for a wide-ranging conversation on the Nightcrawler podcast. I’ve known both Matt and Emmet for a little while now—they had me on their podcast a couple months back—and so I was delighted to offer a little podcast reciprocity and have them on and talk about their approach to investing, how Good Soil is structured to give back through charities, poker, market psychology,  options strategies, and much more. 

“Emmet: I got my bearings back when I was 21 or 22 and got serious about learning about investing. There’s a lot of mass psychology involved. It kind of reminds me of why I was always drawn to poker when I was younger, as well. It’s not only probabilities and math and pot odds, but there’s also a lot of psychology… There’s just so many nuances that I’m drawn to understanding.”

A few more links I enjoyed: 

“In the case of Cassava, Thomas’s clients did not work at the company. And, though he protected their identities, there was one important detail that he did disclose. His clients already had a major incentive to blow the whistle on the company: they had taken a short position on sava. They had made a financial bet against its stock.”
“But I think one thing that’s important to recognize is that this tide of fiscal and monetary stimulus has lifted all boats, not just technology. And it’s interesting to see what is still floating when this tide recedes. And here’s who I still see standing: those companies with stronger secular tailwinds, the best business models, and world class leadership. And I think it’s hard to find another sector that has so much of all of these. So maybe another way to put it is that the Fed can change the discount rate, but not a digital inflection of our economy.”

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