Tag Archives: arguments

Concentration: The Age-Old Question

Summary I’ve made the case for concentration before, and while I still advocate concentration, my original “time” argument was misplaced because of diminishing marginal returns on time. Concentration is largely a function of risk tolerance, which makes it far easier to find an appropriate level for an individual investor than it is for a professional. There is a lot of value in thinking about position sizing in terms of “starter” and “core” positions. Concentration is a subject I’ve written on before. In one of my first SA articles , I made the radical argument for a form of hyper-concentrated investing termed “Focus Investing” whereby one holds 3-10 positions… or even just one. Concentration is still a topic I give an inordinate amount of thought too and I wanted to share some of those thoughts here. This post also follows my first post on stock screening in a series communicating my investment process and philosophy. On Time My thoughts on position sizing have definitely evolved since my first article, and in hindsight, some of my arguments, while nice in theory, don’t hold in reality and my use of them demonstrated my inexperience as an investor. For example: Time The responsible investor follows each and every one of his holdings. It takes a constant amount of time per week to stay up on a company. I would advise at least an hour per week. Again this time is constant, whether that company makes up 2% of your portfolio or 100%… He could own 10 companies and still diligently follow them, but he’d have to devote ten hours instead of one. But wait, if he was willing to devote 10 hours total to stock market research when he held 10 companies, why not spend the same time researching, but while only holding one company? He could spend 5 hours per week keeping up on Apple and another 5 researching potential investments, comparing them against Apple, only considering them if they seemed much more attractive. My argument that investments require a constant amount of time and that 50% of an investor’s research time spent on a single investment is a good strategy ignores one very important principle: diminishing marginal returns or, more practically, the 80/20 rule. See one of my favorite Seeking Alpha articles , which discusses this subject, before continuing. The first hour of research yields more information and more valuable information than the 100th hour. The other problem with the time argument is sunk costs. We all know that a sunk cost should not influence decisions, but that they often do and, sadly, this is true even for decisions that we (the same people who are aware of the phenomenon) make. When you spend weeks researching a company and preparing an extensive, tidy investment thesis and article on the stock, it’s just harder not to take a position, independent of the actual prospects of the investment. While my time argument was somewhat off the mark (though it does hold in extreme cases; time is a serious problem for an actively managed portfolio of hundreds of stocks), I’ve still been a proponent of concentration, to a lesser extent, recently. Professional Constraints Concentration is largely a function of risk tolerance. This is not that meaningful if you are only managing your own money. All it means is that you must discover your risk tolerance and volatility tolerance and find a commensurate concentration level. Thing get tricky, however, when you are managing money for others. Introducing clients means more than one brain and in turn, risk tolerance is involved. What is the appropriate level now? If you are a manager like me with one strategy and one portfolio, then you should stick to the concentration level that you think is best for total returns, but I don’t think the story ends there. There needs to be some consideration that you are a professional and are managing other people’s money. There is a higher standard. This is one good reason to find like-minded clients. If you can withstand volatility, are long-term oriented, and are okay with concentration, look for clients with the same approach. Good luck- they’re rare! My other insight is that adopting a concentrated strategy as a new manager is tough because it requires credibility, to some extent, to be very concentrated. The base rate in investing is market returns and those are derived from a market portfolio, which is very diversified (500 stocks if we assume S&P 500 = market). Naturally, the more concentrated your portfolio gets, the more different it gets from the market and the further from the base rate its returns. You are going further out on a limb. It’s tough to do that with no professional track record. The logical next step is that if you’re a new manager you should be very diversified, but that’s a dangerous path I don’t want to take because it eliminates my positive optionality of earning extremely good returns and I’m in the investing industry for more than just money. Intellectual stimulation and an interesting, meaningful career is the most important thing I seek and the use of money as a means of keeping score and creating value is a big part of the financial aspect. In short, if I’m to succeed, I want to do so on my own terms and that rules out heavy diversification. If that means a slower ramp for my firm, so be it. “Starter” and “Core” I’m at a point now where my view on concentration is somewhat nuanced. Because I employ both deep research and empirical, systematic methods in my portfolio, not all positions will be sized equally – far from it. Right now, I have some positions that are 15-20% of my portfolio and some that are less than 1%. I think this dual concept of “starter” and “core” positions has been very helpful and is worth discussing. For me a starter position is 1% and a core position is much more than that, but the numbers don’t matter as much as the way of thinking about position sizing it represents. A starter position represents something that should, based on empirical evidence, outperform. That is a firm requirement. I talked about this extensively in a previous post . A starter position is also something I’ve done some research on, find interesting, and can model a good expected return with little to no downside on in an adverse case. But for some reason, it’s not fit to be a core position yet. The most common reasons are: I’m not sure I understand it, i.e. it may not be within my circle of competence The expected return I model is not high enough to exceed my absolute return hurdle, i.e. it’s not quite juicy enough I’ve not done enough research or thinking yet, i.e. I need more time Starter positions are crucial to my investment process because they allow me to slow down. Doing research needs to be a treasure hunt for me. I’m only interested in learning about companies when there is the possibility of it being in my portfolio and making me and my clients money. During the research process, it’s so tempting to act on research and invest. It’s hard to delay gratification. The problem is that good long-term investment decisions are made slowly. Gratification must be delayed. However, I’ve found that taking a small starter position up front helps to hold me over. Of course, I don’t do this for everything I research, but obviously far more than I end up taking core positions in as the chart above shows. It also provides an extra incentive to continue to dig deeper in the research. As Tom Gaynor says : When I buy some of something, I’m buying a library card. One of the reasons I buy some of something is to make myself think more deeply about it, read the reports and be more aware of it. It’s hard to overstate the positive impact starter positions have had for me. Not only have they performed well in aggregate, which is how I look at their performance, but they’ve rejuvenated me as an analyst. There was a rough patch where I only published four articles and made four investment decisions, not all of which were good ones, over a period of almost 8 months. (click to enlarge) I researched more than just four companies over this period, but not at as high a rate as I am now and not as effectively. The lack of gratification in the research process demotivated me. There’s no rule saying research needs to be fun for you to be a good investor, but for me I think it does need to be or I won’t find anything to invest in. It needs to be a treasure hunt and starter positions help a lot on that front. At the same time, when my research does, on rare occasions, generate what I think is a really good idea, I’m not going to only put 1% in it. There are times when the level of conviction and opportunity costs make anything but a big position a bad decision and that is when I am willing to take a core position. That is where concentration is needed. And in aggregate, you still end up with a pretty concentrated portfolio. More than half of my portfolio is in 6 stocks despite the large cash position. So I still advocate concentration, but clearly have a more nuanced view now and recognize that position sizing is a far more difficult issue than I initially had thought.

Reeling In Small-Cap Alpha

Summary Stocks of small companies have higher incidences of price volatility and mispricing, increasing opportunities for investors to earn excess returns. Implementing outperforming strategies, such as value or momentum, in the small-cap universe amplifies their alpha-generating potential. High trading costs of small-cap stocks disadvantages passive implementation when compared to skilled active management. Although we live at the edge of the Pacific Ocean, our weekend adventures often take us inland to enjoy the lakes and streams of California and her neighboring states. A favorite pastime is fresh-water fishing. For most, the lure of fishing is a combination of serene beauty, contemplative quiet, and the satisfaction of reeling in as many big fish as possible. We admit that the first two attractions are very appealing in their restorative powers, particularly to office-weary asset managers, but we can’t help being most inspired by the basic challenge of catching a lot of big fish. The folklore claims 10% of fishermen catch 90% of the fish. What do the top 10% know that the others don’t? Investors’ search for alpha is not dissimilar to the strategies of skilled and experienced fishermen. First, the skilled know the right location. They use multiple lines and hooks or lures to increase their opportunities. And they attract greater numbers of fish by chumming – adding scent or bait to the water. In the world of asset management, we can think of risk and mispricing as the chum that attracts alpha. Just as all fishing locations are not equal – contrast the teeming Lake Tahoe with the perishing Salton Sea – not all segments of the equity market are equal in the opportunities they present for finding alpha. Small-Cap Alpha: Abundant, but Unreliable Lake Tahoe is well known for both its abundance and diversity of fish. The academic literature has made a similar case for small stocks, often believed to be a deep pool into which an investor can cast her net and pull out a weighty haul of alpha. Stocks of small companies vary significantly in price volatility, are more prone to defaults, and have high trading costs. In combination, these characteristics create an unpredictable risk distribution for small-cap stocks, and the same traits contribute to their frequently being mispriced. In addition, many known anomalies, or risk factors, have significantly higher return dispersion among small companies, creating numerous opportunities for alpha production. Our research shows, however, that small stocks are not a dependable source of standalone premium. Granted, the small-cap universe is plentiful – there are thousands more small companies than large companies – and diverse – the U.S. economy encourages virtually any type of business or strategy an entrepreneur can envision – but these traits alone are insufficient to ensure small caps will unfailingly produce an excess return. Many market participants believe that, just like value stocks outperform growth stocks, and positive momentum stocks outperform negative momentum stocks, small-cap stocks outperform large-cap stocks. In a recent article (Kalesnik and Beck, 2014), we discuss the evidence that supports the size premium. Table A1 in the Appendix lists the main arguments in favor and against small size as a standalone source of premium. In our view, the arguments against are much stronger than the arguments in favor: we judge the evidence that small-cap companies, in general, outperform large-cap companies to be unreliable. Our advice to the equity investor is to examine that small cap you are considering to be sure it has the alpha-producing qualities you seek – if absent, toss that small fish back, and cast your line again. Small caps are not the fish, they are the fishing spot – not the source of alpha, but rather a place where alpha can be found. A Fertile Fishing Spot Even if small companies are not as a group reliably outperforming large companies, small-cap stocks still hold significant promise for investors – they are a fertile fishing spot for alpha. Small caps, like other investment strategies, benefit from two potential sources of outperformance: 1) exposure to sources of risk that are compensated with higher returns, and 2) systematic sources of mispricing that can be exploited. Small stocks come with higher risk than large stocks as measured by credit rating, delisting probability, and volatility. Table 1 reports the distress and volatility characteristics of U.S. stocks by size quintile. The S&P credit rating difference between small-cap stocks (B rated) and large-cap stocks (A+ rated) indicates the higher likelihood (over 200 times) of smaller stocks being delisted, often because of default. Small caps have a delisting rate of 2.38% versus 0.01% for large caps. The higher price volatility of small caps is evident at both portfolio and stock-specific levels. The portfolio composed of the smallest 20% of stocks is about 44% more volatile than the portfolio of the largest 20% of stocks – 20.6% versus 14.3%, respectively. A portfolio, however, masks a lot of stock-specific volatility. A comparison of the median stock volatility of the highest and lowest quintiles is significantly more striking: the median volatility of the smallest stocks (50.5%) is almost 100% more volatile than the median volatility of the largest stocks (25.5%). Also, the dispersion in stock volatility is much greater for small stocks than for large stocks, with a 25th-75th percentile range of 32.1%-76.0% compared to 19.8%-33.2%, respectively. With a much wider dispersion in stock-level risk, investors looking to capitalize on known risk premia should consider doing their fishing in the small-cap side of the pond. Smaller companies, by virtue of their vast numbers, limited market liquidity, and resultant lower investor demand, tend as a category to have very light analyst coverage. Therefore, much less is known by, or available to, the average investor about the fundamental strength of most small companies. Investors struggle to digest this complexity and to translate the information they are able to discern into efficient prices. Greater instances of mispricing are the practical outcome. Such mispricing creates an opportunity for investors to capture excess returns, much as the fisherman’s baited hook entices the next bream that skims by. If mispricing in the small-cap segment of the market is well known, why does the mispricing persist? Why is it not arbitraged away? One likely reason is high trading costs. Table 2 lists the average bid-ask spreads for each of the size quintiles over the period 1988-2014. The bid-ask spread serves as a proxy for trading costs. Clearly, the average spread is much higher for the smallest-cap quintile compared to the largest over both the entire 27-year period and the last 10 years. Large trading costs make potential trades of small-cap stocks less profitable, allowing the mispricing to persist. Just as a lake with heavier vegetation provides a more fertile environment for fish to thrive, we believe the small-cap universe provides fertile ground for finding highly mispriced stocks. In the never-ending debate over whether certain sources of outperformance – such as value and momentum – arise from risk or mispricing, for our purposes, it actually doesn’t matter! Based on the evidence we have just presented, small caps offer a bountiful location to find alpha. Reeling In Alpha As we stated in the previous section, outperformance requires that risk be adequately compensated by return. In seeking excess returns, we can attempt to exploit the higher riskiness and greater probability of mispricing in small-cap stocks by implementing outperforming strategies – such as those that capture the value, momentum, and quality premiums – within the small-cap universe. Value in small caps. In the simplest interpretation, value strategies favor the stocks of companies with high accounting fundamentals-to-price ratios (value stocks) relative to those with low fundamentals-to-price ratios (growth stocks). The high ratio of fundamentals relative to price can signal that the stock is justifiably risky so that the market is willing to purchase the stock only at a reduced price. Alternatively, the high ratio may signal that the stock is actually underpriced for its fundamentals. In either case, historical experience has shown that buying value companies has been a profitable strategy. For value stocks deemed to be cheap because of higher risk, this characteristic should be magnified in the more opaque small-cap universe, and hence, offer investors a higher premium for assuming that risk. For value stocks attributed to mispricing (i.e., fundamentally strong stocks being temporarily priced too low, and vice versa), returns should be higher when the value strategy is executed in small caps because of the greater potential for the mispricing of small companies. In Table 3 , we show the performance of different definitions of value strategies implemented in both large-cap and small-cap stocks from 1967 to 2014. Value stocks, regardless of the definition of value, 1 outperform growth stocks in both large-cap and small-cap market segments. More importantly, the outperformance of value stocks relative to growth stocks is significantly larger for the strategies executed in small-cap stocks. The t-stats of two of the long-short value strategies implemented in small caps are significant at the 1% level, and one is significant at the 5% level. This compares to two of the same strategies implemented in the large-cap universe being significant at the 5% level, and one at the 10% level. Momentum in small caps. The momentum strategy favors stocks that over a recent period have risen steadily in price. Once identified, these stocks typically continue their upward, outperforming trajectory for an additional period of time; momentum can also assume a downward trajectory. Like the value strategy, the momentum strategy’s ability to deliver excess returns has both risk and mispricing explanations. In our view, the most convincing argument is related to risk, that is, market participants initially underreact to earnings surprises (up or down), only to follow up with a buy or sell action when the earnings information is later confirmed. Similar to the argument we made for implementing a value strategy with small-cap stocks, the risk associated with a momentum strategy would also be amplified when implemented with small caps and would generate a higher return premium. If momentum derives its value-add from mispricing, the fact that small caps are potentially more prone to mispricing should make a momentum strategy implemented in small caps even more profitable. In Table 4 , we compare the performance of the recent winners versus losers in the universes of large-cap and small-cap stocks. The gains from momentum are much higher among the small caps. The t-stats of all five momentum strategies implemented in small caps are significant at the 1% level compared to only two of the five strategies being significant at the 10% level when implemented in large caps. Quality in small caps. Quality investing as a standalone strategy has been gaining a lot of attention. Investing in quality companies is intuitively appealing, but what drivers underlie the strategy? Again, the possible explanations are mispricing and risk. Mispricing theory would argue that investors are unable to correctly translate information beyond simple financial metrics into efficient prices, and risk theory would argue that several metrics related to quality are associated with a distinct undiversifiable correlation pattern, which in a multifactor setting may signal that quality stocks are compensated by a risk premium. If either or both of these explanations are true, we would expect a stronger relationship in the universe of small-cap stocks. A quality strategy encompasses a very broad category of possible signals, creating the danger of focusing on a nonrepresentative outlier. To avoid this potential problem, we identify nine broad groups of quality definitions, and within these groups, 35 narrower definitions. Table A2 in the Appendix provides the definitions. We simulate the performance of the 35 quality definitions in both large-cap and small-cap universes. Table 5 provides these results. 2 We find that for large-cap stocks in the aggregate, quality stocks do not have a performance advantage over junk stocks. 3 By contrast, in the small-cap universe, quality stocks outperform junk stocks. The performance advantage as indicated by the t-stat of the long-short quality portfolio is statistically significant at the 1% level for small caps. In the recent article, “Size Matters If You Control Your Junk,” Asness et al. (2015) document that small-cap companies outperform the market if low-quality companies are avoided. We have a minor quibble with the interpretation of trying to rescue the size premium by controlling for junk. Why not “Size Matters If You Control Your Growth” or “Size Matters If You Avoid Losers”? Arguing that size matters if you control for junk, rather than arguing that most anomalies generate better performance – or any performance at all – when implemented in small-cap stocks, is not much different from arguing, for example, that rebalancing is a repackaged value strategy. At the end of the day, however, our empirical findings and those of Asness et al. are similar: quality small-cap stocks can be a good source of excess return. Both Location and Skill Matter The key to a successful day of fishing is location. The same is true of outperforming in the equity market. The investor must find where alpha is located. Small size – along with value and momentum – is generally considered to be a singularly promising location. Our empirical research, however, calls this general wisdom into question. We find that small size alone does not guarantee outperformance. But small size does offer fertile waters in which to find alpha and reel it in. Both sources of outperformance in investment strategies – compensated risk and mispricing – are amplified when implemented in the small-cap universe because small-cap stocks take both characteristics to the extreme; well-known anomalies show much stronger outcomes when implemented among smaller companies. We conclude that exploiting outperforming strategies within the small-cap universe can deliver excess returns. Because small-cap stocks have high trading costs, implementation skill matters – a lot. Passive implementation of investment strategies in the small-cap segment of the market is definitely disadvantaged versus their skilled active implementation. Active managers can hide their trades, position themselves to narrow the bid-ask spread, and minimize turnover. Ultimately, the equity investor will haul in a larger alpha catch by emulating the skilled fisherman: first, identifying a promising location (i.e., small cap stocks), then using multiple lines and hooks (i.e., implementing value, momentum, and quality strategies to exploit the chum of risk and mispricing in each), and lastly, dangling the lure of skilled active management to tease out the smallest trading costs possible. Endnotes The only value strategy that lacks statistical significance in Table 3 is the strategy defined by dividend yield. It comes with significant volatility reduction, a feature, however, that can make the strategy attractive to some investors. The lower volatility of the high dividend yield portfolio increases the volatility of the long-short portfolio used in the statistical test and renders the difference statistically insignificant. Hsu et al. (forthcoming) document that in terms of Sharpe ratios, the value strategy defined as dividend yields provides an economically and statistically significant advantage. We show only the aggregate results in the interest of space We interpret these findings as a lack of robustness for quality as a broad investment category. It does not mean that individual definitions of quality may not have investment merits; further characteristics may be of interest and deserve more detailed study. References Asness, Cliff, Andrea Frazzini, Ronen Israel, Tobias Moskowitz, and Lasse Heje Pederson. 2015. “Size Matters If You Control Your Junk.” Fama-Miller working paper (January). Available at SSRN. Banz, Rolf. 1981. “The Relationship Between Return and Market Value of Common Stocks.” Journal of Financial Economics , vol. 9, no. 1 (March): 3-18. Hsu, Jason, Vitali Kalesnik, Helge Kostka, and Noah Beck. Forthcoming. “Factor Zoology.” Research Affiliates working paper. Kalesnik, Vitali, and Noah Beck. 2014. ” Busting the Myth About Size .” Research Affiliates Simply Stated, December. Sloan, Richard. 1996. “Do Stock Prices Fully Reflect Information in Accruals and Cash Flows About Future Earnings?” The Accounting Review , vol. 71, no. 3 (July): 289-315. The authors wish to thank Chris Brightman, CFA, and Kay Jaitly, CFA, for their substantial contributions to this article. Appendix This article was originally published on researchaffiliates.com by Vitali Kalesnik and Noah Beck . Disclaimer: The statements, views and opinions expressed herein are those of the author and not necessarily those of Research Affiliates, LLC. Any such statements, views or opinions are subject to change without notice. Nothing contained herein is an offer or sale of securities or derivatives and is not investment advice. Any specific reference or link to securities or derivatives on this website are not those of the author.

Introducing The Tech-Focused Home Run Fund

This is a new portfolio project I’m working on targeting high-growth names in areas of the market I don’t typically invest in. Capital gains are the goal here, as opposed to my usual pursuit of income. I’m using this project to expand my investing horizons. This project started last Friday. Since then I’ve made 7 purchases worth roughly 21% of the fund’s starting value. I am pleased to introduce a new project I’ve started working on, a model portfolio that I’m in the process of building that I’ll call The Home Run Fund . This “fund” is a hypothetical portfolio that I manage and update in real-time focused around “owning” more high risk/high reward, speculative, momentum-driven, exciting companies in search of Alpha with a more short-term, trader-oriented mindset. I wonder sometimes how many other more traditional, conservative, buy and hold type dividend growth investors frequent other areas of this site – window shopping? I’m talking about technology, entertainment, media, biotech and the like that offer much higher growth potential than the typical blue chip, dividend aristocrat type companies that DGI portfolios are usually comprised of. These sections of Seeking Alpha are ones that I frequent as a reader, but don’t often contribute to as a writer. With the creation of this model portfolio series, I hope to change this. In my personal portfolios, I’m very satisfied chocking up on the bat, shortening my stroke, and hitting for average (and collecting those dividends). However, in this portfolio project I will be swinging for the fences. If you can’t tell, I’m a baseball fan. So, there we have it: The Home Run Fund . If you already follow me here , by now you have a pretty good idea about my investment philosophies and stock picking strategy. For those of you who aren’t as familiar with my work on Seeking Alpha, in the most basic sense, I would describe myself as a conservative dividend growth investor with a mind to buy and hold because of my very long-term investment horizon. I have exposure to some of these generally more risky sectors and industries in my personal portfolios; however, for the most part this exposure comes in the form of mature, mega/large cap “legacy” type companies. I focus on wide moats. I focus on strong, reliable cash flows and balance sheet health. More than anything, I am risk averse with capital preservation existing right at the top of my priority list alongside dividend growth. This sort of investing strategy has led to success for me, though I admit it can be lacking in the excitement department. Now obviously, excitement isn’t the name of the game when it comes to investing, making money is. However, I don’t think the two have to be mutually exclusive. This series will allow me to delve into a more risk-laden area of the market, a journey I am pleased to embark on because oftentimes, when it comes to the portfolio guidelines I’ve laid out for myself with regard to capital preservation and a conservative focus on value rather than growth, I find myself having to suppress urges to join in on the fun, exposing myself to some of the popular market darling stocks and their highly speculative valuations. I am not a professional in the financial industry. I manage a vineyard and work as a real estate agent. Portfolio management is a passion of mine; it’s rare that I make it through a day now without wishing that I had studied finance at the university level rather than English and Studio Art. Don’t get me wrong, I loved my time at the University of Virginia and the liberal arts education that I pursued. However, the degrees that I earned don’t qualify me to work in the industry that I currently love – it wasn’t until after graduation that I discovered the stock market and began managing money seriously. I say all of this for several reasons. First, to tamper down any unrealistic expectations. Although I plan on making more speculative bets that will lead to exorbitant gains in this portfolio comprised of hypothetical money, no one should be following my advice here as I admit wholeheartedly that I am a newbie when it comes to investing in high growth/non-dividend paying names. Taking this notion a step forward, no one should ever blindly follow me into or out of any trade; feel free to critique me, laugh at me, or learn with me, but don’t follow my lead without doing your own due diligence. This leads me to the second reason I highlighted my amateur status: to really highlight the point of this series and The Home Run Fund , which is, of course, education. Everything that I write related to finance is for educational purposes. Organizing my thoughts and putting them down onto paper forces me to look for weak spots in my ideas, for holes in my arguments. And once an article in completed, any comments that the piece inspires go on to further magnify my convictions and concerns, allowing me (and hopefully others as well) to take a step back and really digest the information, erasing doubts, and strengthening beliefs about stock picks and the evaluation process. I was recently at a real estate conference and something that a speaker said really stuck with me. The man, talking about being intentional as a salesman said, “If you aren’t uncomfortable, you probably aren’t making real money.” Obviously portfolio management is a bit different than building spheres of influence and making strong sales pitches; however, I do think that it is important for all investors, regardless of management philosophy, to be willing to push his or her boundaries, to make his or her self uncomfortable, all in pursuit of broadened experience and increased knowledge. Like I said before, I sometimes consider making investments in the more speculative names that I will be focusing on in this series in my actual portfolios, though I resist temptation knowing that I don’t likely have the intestinal fortitude required to cope with inherent volatility that comes along with these sorts of investments. Many of the more popular, growth-oriented, momentum-fueled stocks that I plan on targeting within The Home Run Fund have been on my wish list for years. Because of the discipline that I maintain in my personal portfolios and my prioritization of capital preservation, I simply don’t allow myself to invest in these stocks due to rich valuations no matter how much I respect, and even love, the companies themselves. However, looking back I have often regretted this conservative mindset when in hindsight I see that my target prices would have been attractive entry points, eventually leading to big-time gains. I wouldn’t exactly call my reflections on these missed opportunities regret, because I know very well why I didn’t invest in those companies in the first place (they simply didn’t fit into my portfolio’s plan); however, I do think that if I can prove a positive trend with regard to my ability to target attractive entries in less predictable, more volatile names, I would be more willing to put my capital at risk in the markets knowing that my system has proven to be successful in real time and warrants investment attention. To me, experiential knowledge is the best kind. The emotional responses to success and failure leave a much bigger impact and stick with me much longer than most academic study. In other words, “feeling” a loss or gain is much more tangible than simply reading about one or the other. This project will enable me to experience these feelings to a certain extent without putting my capital at risk in the markets. The real-time nature of this portfolio project will help me dial in my evaluation system in areas of the market that are rather foreign to me. Doing it this way should be more effective than simply back testing ideas. Although this “Fund” will be hypothetical, you can rest assured that I will be performing the same level of due diligence when making selections for this portfolio as I do my own. I am too competitive and (shamefully) prideful not to. I want positive results here; I want to prove to myself that I am just as capable of management success in a more speculative environment as I am when really crunching the numbers and patiently waiting for safety margins to widen in the blue chip dividend names. I hope that you all will take this ride with me; with any luck, it’ll be an enjoyable experience for all involved. As always, I look forward to your feedback (probably more so now than ever, because I’ll be dealing with trades in this portfolio that are undoubtedly out of my comfort zone). So, without further adieu, let me introduce the basic ground rules and strategic guidelines for this project: I will be giving myself $100,000 hypothetical dollars to build this portfolio. There will be no new cash added throughout the process. The primary goal of this portfolio is capital appreciation. Unlike my actual portfolios, income will not play a large role in stock selection. All income generated within the portfolio will be pooled in with the cash reserves fund and put to work when making future purchases. I will be comparing this portfolio to all relevant benchmarks in pursuit of Alpha. Unlike my personal portfolios, here I will be focusing more on small/mid cap companies. I will be “buying”, “selling”, and “short-selling” individual stocks or bonds. I will not be using option strategies in this portfolio. I will also not own mutual funds, index funds, close ended funds, exchange traded notes, or the like. I will give myself 30 free trades a month for this fund (the same deal I get at my brokerage); although I doubt I will ever exceed that amount, any trades above the 30 trade threshold will cost $7.99. I say I don’t plan on exceeding that number of trades because I plan on this portfolio being much more highly concentrated than my own. I don’t have set in stone targets with regard to number of holdings or asset allocation. I would like to maintain between 10 and 15 holdings (much less than the 50+ I own in my actual portfolio), though this is subject to change depending on price action and opportunities that arise in the markets. There will be no weighting or section allocation targets within the fund. Being a value investor at heart, I will be looking to capitalize on contrarian moves, more willing to take risks and attempt to catch falling knives here than I am within my actual portfolios. Similar to the portfolios I currently manage I will be looking to own companies with wide competitive moats. However, in The Home Run Fund I will also happily expose myself to companies with very narrow moats assuming that they offer a product or service that I deem to be by and large the best in breed in their industry. I will also be looking to give myself exposure to long-term trends that I believe strongly in. I do this in my actual portfolios as well, though value plays a bigger role than my belief in a trend. In this portfolio I will look past valuations when I truly believe in a movement, especially if it’s expected to play out in the short-term. And lastly, and probably most importantly for this project, I will do my best to check my fear of failure at the door when entering the confines of The Home Run Fund . This fear and reluctance to put my capital at risk has caused me to lose out on potentially lucrative opportunities in the past. I already manage a relatively conservative portfolio, that isn’t the point with this one. I began making purchases for The Home Run Fund last Friday during regular market hours. Just as I did with these purchases, I will be posting stock talks here at SA focused on each purchase/sale. This allows for transparency when it comes to my entry and exit prices. It also allows anyone interested to keep track of moves made by the “fund” in real time giving me time to write and publish detailed trade summaries. Here are the trades I’ve made thus far and a quick snapshot of the portfolio as it sits today. I will briefly describe my reasoning for each selection in this piece, but for the sake of word count, I will be posting primary ticker pieces on each trade made as well, covering my thought process involved in much greater detail later. Starting out the Fund purchasing shares of Alphabet (NASDAQ: GOOGL ) (NASDAQ: GOOG ) and Amazon (NASDAQ: AMZN ) was a relatively easy choice. It’s too bad that I waited until after their recent stellar earnings reports to begin this project. If I had started this a week ago I would have saved a nice chunk of change on these two trades. However, I couldn’t deny myself exposure to these two transformative companies. I think that any portfolio focused on growth should seriously consider holding these two names. Both companies have expanded their business operations to the point that they have their fingers in a myriad of potentially highly profitable cookie jars. I’ve been following both Google and Amazon for some time now and never allowed myself to pull the trigger due to their valuations and lack of dividend payments. Well, even though I’d obviously love to pick up shares here on dips, I decided it was best to simply bite the bullet and initiate positions regardless of current valuations because of the massive growth prospects both companies offer. (click to enlarge) Biogen (NASDAQ: BIIB ) is a company that caught my eye due to recent weakness in the biotech space. Unlike many of its brethren in the Nasdaq Biotech ETF (NASDAQ: IBB ), Biogen is a highly profitable company. Sure, recent question marks have arose that are company specific, but for the most part I think this company has traded down because of industry wide fears sparked in part by politicians posturing on price gouging and drug prices. Even if recent events in the space lead to a restructuring of the pricing models, I simply don’t believe that any changes will be impactful enough to justify the sort of selloff that BIIB has experienced as of late. Also, I am interested in the massive potential that BIIB’s pipeline could have in store, namely in the treatment Alzheimer’s disease, something that has been very difficult and elusive for biotechs thus far. Whole Foods Market (NASDAQ: WFM ) is a company that I own in my personal portfolio. I actually increased my own position by 15% at this $30.75 share price. I love what this company represents. I think the health foods movement is a long-term trend, not a fad. I think science is increasingly pointing towards the fact that humans should be consuming more natural, less processed foods. And, not only this, but I love the experience that WFM stores offer. Shopping there is a pleasure (albeit a relatively more expensive one). I understand that comps are slowing, but I think that store count growth will offset this. I also think that after recent weakness in the health food-focused grocer industry, M&A activity will pick up in the space and WFM could benefit from this, as either an acquirer or an aquiree. I like Blue Buffalo Pet Products (NASDAQ: BUFF ) for many of the same reasons that I like WFM. Just as I think the health foods movement is real and will be long lasting, I think the humanization trend with people and their pets is real as well. I think wholesome, natural pet food products will continue to gain market share within the pet food industry and BUFF is best situated to benefit from this. I like BUFF as a pure play in the space rather than the other larger conglomerate type companies that offer wholesome natural pet foods as a very small part of their overall operations. This company has fallen hard since its unfortunately timed IPO in late July. Shares initiated trading in the $27 range and now $10 cheaper, I find the value much more attractive. GoPro (GRPO) and Ambarella (NASDAQ: AMBA ) trades were announced together because I view both positions in a similar light. First, looking at GoPro I see a company with a best in breed type product that comes with a lot of fanfare. The cameras that this company makes are top notch and I don’t see it losing its spot at the top of the wearable camera space anytime soon. I also wouldn’t be surprised to see GoPro transition into the media space with some of the unique content that its hardware can create. It already has relationships with many of the biggest media and entertainment companies. Original content seems to be all the rage these days and I think as GoPro matures (if it isn’t bought out before then), it will head in this direction. AMBA makes chips for GoPro, though I see this as a more general play on this industry, as well at the drone space, which AMBA has made strides in. With the holiday season coming up, I think we may be in for another GoPro Christmas. Also, I wouldn’t be surprised if drones are one of the more popular presents purchased this year (and in subsequent years as well). Both companies have experienced major weakness over the last several months, bringing their valuations down to much more attractive levels. I know that I’m attempting to catch falling knives here but I think over the long-term I will be rewarded. Here is a snap shot of what the portfolio looks like currently. (click to enlarge) Like I said before, I hope that we’re all able to take something away from this project and put it to use in our own portfolio management practices. I hope you enjoyed this introduction and look forward to all of The Home Run Fund pieces on the way. Please feel free to leave advice, recommendations, or critiques in the comment sections as we move forward. Best of luck all!