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Subject:  Re: Basket cases? Date:  5/11/2011  12:22 AM
Author:  blaueskobalt Number:  133 of 151

I view the basket approach as a psychological tool recommended by the GG team to help safeguard us from the stress caused by the volatility of the Chinese microcaps (judging from the boards, it has not been very successful in that regard).

Mathematically, a 40% allocation to YONG as part of a basket designed to comprise 5% of a portfolio is no different than a 2% YONG position in the overall portfolio, and one is either comfortable with that or not. If not, one should either take a lower allocation or simply not own any at all. When it's put in a basket, it masks the volatility, but to what end? To trick one's self into feeling comfortable holding a more volatile stock than one is comfortable holding? That sounds like a recipe for disaster. If one is not comfortable holding a 2% YONG position, one should not hold a 40% YONG allocation within a 5% basket.

On the other side of the coin, I would not personally bother holding a 1% position in KO (i.e., a 20% allocation within a 5% basket). I want a (full) 3-10% position or none at all (or, if I want a basket with KO, I'll just buy a low-cost index). This is partially because of transactional costs and partially because I want a concentrated enough portfolio that I can keep on top of all of my holdings--which, for me, means less 40 total holdings. For Chinese microcaps, 0.5-3% overall position sizes make sense given the risk, but--to make up for that--positions that are less risky must have heavier weightings.

The first week the WSJ launched their weekend investor section, there was an article on how to get more out of the cash position of your portfolio. Their recommendation was to allocate some of your "cash" position to bonds and high-yielding equities, but still consider that part of your designated "cash basket." That makes no sense and is the worst financial advice that I have ever heard. Obviously the China baskets are vastly different in that they don't try to hide risk, but they do add a layer of opacity, and I cannot help but think that is a bad thing.

I don't use the basket approach per se, but I do have a collection of small positions in risky Chinese microcaps (I similarly have a couple of similarly-sized positions in speculative alternative energy companies). That being said, if the team wants to keep recommending them as a tool, I have no problem with that; in fact, I welcome their recommendation of baskets if it enables them to cover some attractively-valued companies that they would otherwise not feel comfortable covering.

NoFate, if I understand you correctly, your issue is twofold: first, with baskets' effect of adding opacity to risk taken (as I discuss above and agree with you). Second, your issue seems to be with Chinese microcaps generally--that the risk is so high that an appropriate weighting would be so low (say 0.1% of a portfolio) that--even if the stock were to triple--it wouldn't move the needle enough to justify the risk and/or hassle. Your second issue is more a reflection of your personal risk preferences than anything else, IMO. It is a fine and logical position to have, but I believe that there are other risk preferences that are also fine and logical, and I think that the team works hard to run a service that accommodates a range of risk preferences--which is good.

After having a spectacular (but almost meaningless to his overall portfolio) failure in XPRT, hedge fund manager Whitney Tilson has some extremely applicable things to say:

Returning to YONG specifically, I actually think that it looks like a more attractive investment now than in mid-2009 (on a price- and risk-adjusted basis), so I find it interesting that your analysis and risk preferences lead you to conclude that it not worth owning now (though presumably you felt it was worth owning at some point in the past):

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