I've recently been thinking about portfolio management and the best way for investors to structure their portfolios.
This is a fascinating and involved topic, and one that I think has no real answer. Complicated models and spreadsheets are all very well and good, but, in reality, how you build your portfolio has more to do with your own tolerance for risk, time available and understanding of how investment markets work than anything else.
Robo advisors might have been constructed with the best and most rigorously tested algorithms, but in a stressed marking environment, no matter how scientifically your portfolio is built, if you cannot deal with a 50% drawdown, there is entirely no point whatsoever having any allocation to equities. If you cannot tolerate volatility, you may just end up selling at the bottom.
Learning from the best
That being said, I want to take a look at some of the most successful investors of all time to try and see if we can learn anything from the way they manage or managed their portfolios.
We will start with the best investor of all time, Warren Buffett (Trades, Portfolio). We don't know much about his personal portfolio, but we do know he owns JPMorgan (JPM, Financial) and a few other select stocks, including, of course, Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial). We know more about the Berkshire Hathaway portfolio, and its makeup.
The portfolio is structured around several key positions with numerous smaller holdings. Buffett has said in the past that he does not like diversification, and the first part of the portfolio supports this view, though the other smaller holdings seem to go against it.
When it comes to concentration, Charlie Munger (Trades, Portfolio) has the most concentrated portfolio of all at the Daily Journal (DJCO, Financial) with just four equity holdings.
If we look back at some other value investors throughout history, we know Benjamin Graham, Peter Cundill, Irving Kahn, Walter Schloss and the rest of the Super Investors of Graham and Doddsville used extremely diversified portfolios with at least 30 different holdings, an approach advocated by the father of value investing.
Seth Klarman (Trades, Portfolio) uses a similar approach. At his hedge fund, Baupost, which has $30 billion in assets under management, Klarman only has around a third of total assets invested in public equities. The rest of the funds are invested in credit and other off-market assets, such as real estate. Even though the equity portfolio may appear to be relatively concentrated, in aggregate, I don't believe Baupost's portfolio is extremely focused. We don't know the exact figures, but I would say the portfolio of this value investor has more in common with Graham than with Buffett. I would put Howard Marks (Trades, Portfolio) of Oaktree in this bucket as well.
Joel Greenblatt (Trades, Portfolio) is another highly successful value investor. He has adopted an approach that sits somewhere in the middle of Buffett and Graham. His well-known 'Magic Formula' style of investing advocated buying the 30 cheapest stocks that qualify for the screen.
A clear conclusion
This is just a short list of some of the most significant investors of all time, but it also outlines who I think are the most successful.
What does it show us? I think the primary takeaway is the fact that, on average, most successful value investors have used a diversified portfolio approach, with 30 or more items (stocks, bonds or other assets). Few others have been able to successfully replicate the method used by Munger and Buffett of just buying and holding a handful of well-picked stocks.
Disclosure: The author owns shares of Berkshire Hathaway.
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