Opinions
Christine Horoyski A Comment -- General Comments From an Expert A Commentary N/A Feb 22, 2010
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Investing 101: Proper Position Sizing
The first key risk management practice we want to discuss is proper position sizing within an investment portfolio. Position sizing is a personal decision, but there are a few key factors to consider when deciding how much weight an individual position should be given within a portfolio:
- The position should be large enough that if an investor is right, it contributes to their net worth
- The position should be small enough that if that investor is wrong, it will not be a major setback
- The volatility of an individual name should be taken into consideration – less volatile names can have a higher weighting and vice versa
- Beware of overconfidence – if it seems too easy, it probably is
A lot of the practices around proper position sizing involve effective diversification. While this is a personal decision, in general, we are comfortable with letting a position reach a maximum weighting of around 7%. The theory is that on average the market returns somewhere between 6% to 8% per year, and if an investor has a stock position at a 7% weighting that subsequently goes to 0% while all other positions in the portfolio remain flat for the year, the investor is only setback by about one year (assuming the market returns ~7% in that year).
There is no right or wrong number of stocks that an investor should hold in one’s portfolio, however, many studies have shown that a portfolio with 20 or more stocks helps to remove company-specific risk from a portfolio. To use an example, at the extreme end, a portfolio with only one stock will be severely exposed to the individual risks of that company, whereas an investor that increases the number of stocks in a portfolio will reduce the individual risks from the underlying companies. The investor is then theoretically only left with the risks of the broader market (interest rates, inflation, recession, etc.). There is also a risk of over-diversifying, where too many individual stocks will begin to erode one’s ability for higher returns.
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Markets want to go higher after the earlier 15-20% pullback. He expects markets to eclipse all-time highs later this year, but there will be periods of volatility, especially with the U.S. crazy at times. The World Bank was correct to downgrade global growth this year, given data. In slow-growth periods, tech tends to do well and will lead to interest rate cuts. The U.S. is pricing this in as yields decline, but positions markets to move up.
Reality is that, off the bat, companies are working hard trying to eat some of the tariff costs. The questions are how long will tariffs be in place and how high will the costs be? Ultimately, companies will have to assess that.
Inflation is still pretty sticky, though it could moderate. For those who want rate cuts, moderating inflation in the near term is positive. That's going to be a bit tricky. Over the last few months we've seen an uptick in commodity prices, and that will start feeding through into the inflation data. Energy prices, for example, have started to tick up again.
The market's signalling that inflation is still a concern, because inflation-oriented assets are outperforming. He doesn't see any change in that.
It's interesting. For all of the people who are concerned that tariffs are going to slow things down, the signalling from the market has been quite different. Think about where leadership is. Financials continue to lead, especially the capital markets banks and investment banks. Also seeing strength in industrials in general, which sort of belies concerns about the economy.
When you look at defensive sectors (consumer staples, REITs, bond proxies), there's no sign of any relative strength or performance there. If things were slowing down, you'd expect them to pick up.
We're in the middle of bond auctions, 10-year today and 30-year tomorrow. Longer-term yields have been building in a bigger and bigger premium for the term that money will be locked up. Again, that speaks to the risk that governments continue to spend and rack up more debt.
So more inflation-oriented assets are performing well -- basic materials, gold in particular, uranium, fertilizer stocks. Those don't point to a deterioration in the economy.
The more economically sensitive sectors are gathering steam. Healthcare, for example, isn't one of them; US government is trying to hold cost inflation down. Healthcare doesn't have a lot of pricing power right now to pass costs through. He's trying to focus on companies that generate tons of cash, growing cashflow, with a nicely growing dividend stream.
Massive buildout in infrastructure. Massive pickup in adoption. As with every major technology that comes along, the newest one gets adopted faster than the last one. Adoption is very high across companies. We're still learning where it's going to be most useful. Some of the largest of the large caps (META, NFLX) are the biggest beneficiaries.
One of the things his team's looking at right now is that it seems some of the regulations surrounding the semiconductor industry will be reduced (specifically China, but other countries as well). That could mean an expanded market for the semi manufacturing equipment companies such as KLAC. AVGO has also been a strong performer, and he owns some NVDA. Those two names have strong relative price performance, are economically sensitive, cyclical, and have pricing power.
The big themes that led into the tariffs were all economically sensitive. Rare that one piece of news, even a big piece of news, completely changes the picture. Biggest structural change we've seen in years is the generational low in interest rates we saw in 2020. If so, as in the late 1940s, we'll get 20 years of rising long-term interest rates. Defensive stocks and bonds have a hard time in that environment.
What's working are things that benefit from inflation. Even though near-term data's a bit weaker, the stocks that benefit from inflation are leading, and so his team is leaning towards those things that give them an inflation hedge.
A.I. Themes To Watch: Advanced data analysis and pattern recognition
AI systems can analyze vast amounts of financial and alternative data at speeds and scales far beyond human capability. These systems identify market patterns, trends, and investment opportunities that traditional analysis might miss, leading to more informed and timely investment decisions. This data-driven approach is especially valuable in sourcing deals, uncovering hidden market trends, and flagging emerging industries or undervalued assets before competitors notice. That being said, this trend is more likely to favour traders than long-term investors. Longer term investors still have time, if a company or trend really is going to be the next greatest thing. If you buy a stock that is going to compound 10,000 per cent over a decade, you do not need to be there for the first 200 per cent.
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China: The US needs their rare earths for smartphones, semis, EVs, lasers, fighter jets, tablets and other devices. What were we thinking when we slapped tariffs on China before settling the rare earths issue?? Brazil: Need an immediate deal with them, because they have one-fifth of the world's rare earths. Vietnam: Also we need to strike a quick deal with them for their rare earths. Australia: same.