The moves that I made in February represent an evolution in my approach to managing the All-Cap Value portfolio. As I stated in this post back in September of 2012, my emphasis has been on buying stocks of what I believe are good companies, when I believe that they are cheap.
The result of such a strategy is typically a highly concentrated portfolio, based on my belief that in normal times the market simply does not serve up a steady stream of attractive quotes on high quality stocks on a regular basis.
While I don't have a problem with holding a highly concentrated portfolio of companies that I have a high degree of confidence in, lately I have found myself unable to find enough opportunities to fill out the portfolio.
As a result, in recent months I have held large cash positions and big positions in the Vanguard Total Stock Market Fund (VTI), a proxy for the broad U.S. market. While there is something to be said for both of these options, there is a third option for filling out the portfolio that I believe is superior to either and more appropriate for a value portfolio.
That option is to hold a basket of stocks selected primarily on cheapness and secondarily on quality. As each position in the basket is much smaller than positions selected for value and high quality, the risk of holding lower quality stocks is diminished to the entire portfolio taken as a whole.
This approach goes all the way back to Ben Graham. In more recent times, numerous published studies, including one of my own, show that diversified portfolios of stocks selected on value or a combination of value and quality have historically outperformed the market and yielded what I believe are possibly attractive returns to investors who have the discipline to stay with the strategies.
Going forward then, the portfolio will be split between larger positions that will make up at least five percent but no more than twenty percent of the portfolio when initiated, and a basket of smaller positions with each holding typically accounting for one to two percent of the portfolio when initiated.
Another way of putting this is that part of the portfolio will be managed with an active value style and the remainder will be managed with a more passive value style. The proportion of the portfolio allocated to each style will vary with the number of high conviction ideas that I hold at a particular time.
I replaced these holdings with a basket of 14 stocks that I judged to be undervalued based on my rigorously tested quantitative and qualitative criteria, and with increases in the portfolio's positions in Microsoft (MSFT) and Chesapeake Energy (CHK).
I was confident enough to move on such a large number of stocks at one time because I was already familiar with the names and because the position sizes for the individual stocks in the basket were small relative to the portfolio.
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