“The idea that you should own a little bit of everything is a concept rooted in market efficiency. If the markets are efficient, you cannot outperform anyway, so by owning a bit of everything in just the right proportions, you stand to reduce portfolio volatility, while at least avoiding underperformance. This is the best that you can hope to do in an efficient market. For any fundamental-based investor, this is complete hogwash. Investment comes in the following varieties: undervalued, fairly valued, and overvalued. Price is everything, and every investment is undervalued at one price, fairly valued at a higher price, and overvalued at some still higher price. You buy the first, avoid the second, and sell the third. Having a goal of diversification, rather than owning value, causes investors to take their eye off the ball. It is a refuge of investment wimps, owning a little bit of everything to avoid being wrong, but thereby ensuring never being really right either.”
- Seth Klarman, Margin of Safety
“We have to work extremely hard to find just a very few attractive investment situations. Among the few we do find, the expectations vary substantially. . . . There is one thing of which I can assure you. If good performance of the fund is even a minor objective, any portfolio encompassing one hundred stocks is not being operated logically. The addition of the one hundredth stock simply can’t reduce the potential variance in portfolio performance sufficiently to compensate for the negative effect its inclusion has on the overall portfolio expectation. Anyone owning such numbers of securities after presumably studying their investment merit is following what I call the Noah School of Investing — two of everything. Such investors should be piloting arks. While Noah may have been acting in accord with certain time-tested biological principles, the investors have left the track regarding mathematical principles.”
- Warren Buffett, 1965 Shareholder Letter
“Middle of the Road” aka “Diversification” is often a poor investment compromise. You don’t have enough concentration to see significant upside … and yet with conventionally popular names – where unanticipated tail risks can dislodge a massive crowd of investors – there is significant downside danger.
With its obvious faults and glaring lack of upside, why does the lukewarm ‘diworsification’ approach still persist?
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