Friday, June 09, 2006
Weekly summary: No escape from the House of Pain
My portfolio wasn't able to recoup any of yesterday's losses and consequently, I finished down $16,806 (2.3 percent) for the week. However, because my portfolio managed to avoid much of the market plunge in the first half of the week, I still outperformed the S&P 500 (down 2.8 percent), NASDAQ (down 3.8 percent), and Russell 2000 (down 4.9 percent).
I must admit it is hard to avoid feeling like a chump when you're long a market that is as bad as this one, especially when other traders are making a killing on the short side. Twice in the past four years (fall of 2002 and summer of 2005) I have thought about moving into cash and waiting for the market to perk up. Both times I didn't, and both times my instinct proved correct, as the market rallied and my portfolio achieved huge returns. Perhaps if I were nibble, I could have gotten out in time and then jumped back in, but unfortunately it is impossible to be nibble with a portfolio like mine.
You see, the problem with my portfolio, and I'll be the first to admit this, is that liquidating it is akin to turning around a huge ocean freighter. You can do it, but it takes lots of time. This is an inevitable consequence of being extremely well diversified (as of today, no single position exceeds 4 percent of my portfolio) and being heavily invested in relatively illiquid stocks. Still, I have no intention of giving up on my basic strategy of investing in mircocap value companies given my track record of success with this strategy. However, I have been thinking recently of starting a new portfolio that would focus more on liquid stocks that could be more easily traded. That would allow me to easily jump in and out of the market, both on the short side and on the long side. I've also thought about using protective puts to limit my losses if the market declines. As my thinking evolves on these issues, I'll keep you posted.
I must admit it is hard to avoid feeling like a chump when you're long a market that is as bad as this one, especially when other traders are making a killing on the short side. Twice in the past four years (fall of 2002 and summer of 2005) I have thought about moving into cash and waiting for the market to perk up. Both times I didn't, and both times my instinct proved correct, as the market rallied and my portfolio achieved huge returns. Perhaps if I were nibble, I could have gotten out in time and then jumped back in, but unfortunately it is impossible to be nibble with a portfolio like mine.
You see, the problem with my portfolio, and I'll be the first to admit this, is that liquidating it is akin to turning around a huge ocean freighter. You can do it, but it takes lots of time. This is an inevitable consequence of being extremely well diversified (as of today, no single position exceeds 4 percent of my portfolio) and being heavily invested in relatively illiquid stocks. Still, I have no intention of giving up on my basic strategy of investing in mircocap value companies given my track record of success with this strategy. However, I have been thinking recently of starting a new portfolio that would focus more on liquid stocks that could be more easily traded. That would allow me to easily jump in and out of the market, both on the short side and on the long side. I've also thought about using protective puts to limit my losses if the market declines. As my thinking evolves on these issues, I'll keep you posted.
# posted by Stockcoach @ 5:20 PM 
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I thought I would introduce some things for you to think about, but do it in the form of questions versus your own comments.
"This is an inevitable consequence of being extremely well diversified (as of today, no single position exceeds 4 percent of my portfolio) and being heavily invested in relatively illiquid stocks."
Is being "extrememly well diversified" really only a function of having lots of the same kinds of stocks? Is it possible that there is more to it than that, like having different kinds of asset classes fitting different economic times?
"Still, I have no intention of giving up on my basic strategy of investing in mircocap value companies given my track record of success with this strategy."
Is it possible, even despite having done this for 5 years or so, that you simply don't have enough experience with what the economy can do over longer time frames to judge that what was worked so far for you might not work under all economic conditions?
"This is an inevitable consequence of being extremely well diversified (as of today, no single position exceeds 4 percent of my portfolio) and being heavily invested in relatively illiquid stocks."
Is being "extrememly well diversified" really only a function of having lots of the same kinds of stocks? Is it possible that there is more to it than that, like having different kinds of asset classes fitting different economic times?
"Still, I have no intention of giving up on my basic strategy of investing in mircocap value companies given my track record of success with this strategy."
Is it possible, even despite having done this for 5 years or so, that you simply don't have enough experience with what the economy can do over longer time frames to judge that what was worked so far for you might not work under all economic conditions?
# posted by 
: 10:34 AM, June 10, 2006
: 10:34 AM, June 10, 2006
The answer to the first question is yes. This blog shows my stock portfolio. I do have other assets (bonds, company pension, etc).
With regards to the second question, I'm certainly well diversified within the small cap space. The issue is whether I should diversify beyond small caps. I am not convinced I should, at least not in a big way.
In the past 5 years, investing in small caps was an obvious choice since that particular asset class was outperforming the market. On top of that, I was outperforming the benchmark small cap index by a wide margin. If I had invested in large caps, there is no way I could have outperformed a large cap benchmark index by the same magnitude since large cap stocks are too efficiently priced. So the question is this: suppose I can outperform a small cap benchmark index by 10 percent per year by investing in small caps and outperform a large caps index by 3 percent by investing in large caps. Suppose also that the large cap benchmark will outpeform a small cap benchmark by 2 percent. Given this scenario, I should still stick with small caps, even even though they will underperform.
Now it is possible that I've just been really lucky over the past 5 years. I accept that possibility. If I didn't, I would leverage myself to the max to magnify my returns. Only time will tell. If I end up failing to outperform by the small cap index and the broader market for an extended period of time, then I will liquidate and just buy an index fund.
With regards to the second question, I'm certainly well diversified within the small cap space. The issue is whether I should diversify beyond small caps. I am not convinced I should, at least not in a big way.
In the past 5 years, investing in small caps was an obvious choice since that particular asset class was outperforming the market. On top of that, I was outperforming the benchmark small cap index by a wide margin. If I had invested in large caps, there is no way I could have outperformed a large cap benchmark index by the same magnitude since large cap stocks are too efficiently priced. So the question is this: suppose I can outperform a small cap benchmark index by 10 percent per year by investing in small caps and outperform a large caps index by 3 percent by investing in large caps. Suppose also that the large cap benchmark will outpeform a small cap benchmark by 2 percent. Given this scenario, I should still stick with small caps, even even though they will underperform.
Now it is possible that I've just been really lucky over the past 5 years. I accept that possibility. If I didn't, I would leverage myself to the max to magnify my returns. Only time will tell. If I end up failing to outperform by the small cap index and the broader market for an extended period of time, then I will liquidate and just buy an index fund.
Assuming your portfolio outperformance is not due to luck, then why alter your strategy? Jumping in and out of the market isn't usually successful for most investors.
Marty Whitman, famed value manager of the Third Avenue series, points out in a recent updating to his book, The Aggressive Conservative Investor, that he successfully invested in Japanes equities (about 10% p.a.), even while the Nikkei declined from 20,000 to 10,000 over the period.
So I ask again: Why change your strategy?
Jay Walker
The Confused Capitalist
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Marty Whitman, famed value manager of the Third Avenue series, points out in a recent updating to his book, The Aggressive Conservative Investor, that he successfully invested in Japanes equities (about 10% p.a.), even while the Nikkei declined from 20,000 to 10,000 over the period.
So I ask again: Why change your strategy?
Jay Walker
The Confused Capitalist
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