Skip to main content
No. of Recommendations: 2
I'd like to hear more about how you decided on a max position size of a position that has appreciated to 10-12% of the portfolio. My question is: Isn't overvaluation the main risk with this position size, and not purely concentration? For example, if the stock has stayed below fair value, but has appreciated in line with significant value-creation, why not continue to let it run?

Hi AJner,

You ask a very good question. After all, we at TMF espouse that we should let our winners run. David G, of all of us, is the best at doing this, with some fantastic results (look at his own investment in AOL from way back when or Netflix more recently).

I'm still exploring this role of investing other people's money and doing it with the philosophy / strategy of messed-up expectations (MUE). And it's both considerations that lead me to limit the holding size to 10% to 12% of the portfolio. Let's see how well I can articulate these thoughts (which, of course, helps clarify my thinking).

In my own portfolio, I had one position that I let grow to become 30% of the portfolio's value. It was to the point that 90% of the daily change in portfolio value was due to that one stock. Pretty drastic. So, I trimmed it back to about 10% and am now letting it grow again (actually, shrink, given the past couple of days, haha). But what I do in my own portfolio, with my own money, I cannot as readily justify doing with other people's money. The $17,000 I'm being given over the course of this year ($5,000 to start, $1,000 per month for a year) is not my money. I have to answer to my manager, our company's CIO, and our company's CFO on what I'm doing with their money (actually our company's, but they're the agents). It's a completely different dynamic than investing just for myself and my wife. At least, I'm finding it so.

Then there's how MUE plays out. I've used MUE in the past for a few positions in my own portfolio, and it's worked fairly well. Nokia (since sold), Transocean, 1/3 of my BP position, Veolia. But I haven't used it exclusively. That's what I'm doing here. And I'm not really sure where it's taking me, at least not completely.

I suspect what's going to happen is that as Mr. Market gets over whatever fear triggered the MUE to happen on the low side (such as Transocean last summer and fall), the priced-in expectations will rise. I'm already seeing that with Transocean. That comes about mainly from a rise in share price. Once those expectations are more reasonable based on what the company's been able to do in the past, does the share price rise slow down? Does it keep rising and overshoot to the high side so that expectations are messed up in the other direction (too much growth priced in)? I'm not sure, yet, though I suspect that the situation will be different for every company.

What do I do when that happens? Well, on the overshoot result, the answer is pretty obvious: Sell, probably in stages just as I bought. On the matching result, however?

Well, theoretically, I should still be able to get 15% annual returns (on average) as long as the company performs as modeled (ha!) and the market is reasonable (ha!), because that's the discount rate I use. So one could argue for a hold. But I'm also bound to have some misses where the low expectation was actually justified. My goal is a portfolio average annual return of at least 15%, and if I have a few failures, I have to have those that grow faster than 15% annually to compensate. So can I afford to have money sitting by, earning "only" 15%?

Further, am I giving up other, larger returns? And if I am, am I hurting the returns I could be getting on the money other people have given me to invest?

This ties into style drift, as well. I proposed a certain style for investing, and an implied consequence of that style is that it won't be long-term buy and hold. Would holding on be style drift?

Anyway, those are the thoughts I had both before writing the proposal and afterward as I've continued thinking about MUE investing with other people's money. Not sure where the answers are at the moment, but I'll get there.

Print the post  


When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.