QUALIPORT
Should You Run A Focused Portfolio?

By Maynard Paton (TMFMayn)
April 29, 2002

The Qualiport is an educational portfolio. By investing in great companies at attractive valuations, its aim is to beat the stock market over the long term. To achieve this goal, the Qualiport has adopted the 'big bold bets are best' style of investing. However, by holding only a handful of different shares and ignoring the conventional wisdom on diversification, could the Qualiport be leading new investors astray?

Focus

In terms of percentage weightings, here's how the Qualiport presently stands:

Holding                        Percentage

PizzaExpress                      11%
Lloyds TSB                        18%
Johnston Press                    24%
Carpetright                       18%
Emap                              22%
DFS Furniture                      5%

Cash                               2%

So, should you run a portfolio on similarly focused lines? If you're out to beat the market (and if you're picking individual shares, you should be), then the answer is yes. Statistical common sense should tell you that your only hope of beating the stock market is via a concentrated portfolio. Simply, the greater array of companies or sectors your portfolio holds, the less chance you'll have of significantly diverging from the stock market average.

Exactly how many different companies and industries are represented in your portfolio is up to each individual. However, there are two key points to remember:

* Nobody can become an expert on everything, and;
* Great investment opportunities do not appear every day.

Be prepared

The market occasionally acts in an irrational manner. However, while the ensuing panic and greed allow investors to buy or sell at very favourable prices, you've got to determine whether the stock market has overreacted in the first place. 

The trick here is in the preparation. Having previously investigated a company and monitored its progress, making an investment decision becomes all the more straightforward when, for example, fear envelops the market and share prices go into freefall. If you've already done your homework, stock market overreactions can be readily detected.

Of course, dutifully monitoring suitable companies takes time. However, life can be made easier by sticking to businesses in the same, familiar, industry. But even with a 'circle of competence', keeping a regular eye on more than, say, twenty different companies will dilute your research efforts. And inadequate analysis will always lead to a poor portfolio performance.

Although the stock market does act irrationally on occasion, great buying or selling opportunities are hardly day-to-day occurrences. With every investor having the same market-beating ambition, genuine bargains do become few and far between. This infrequency, especially with having a limited universe of shares, means you just have to buy 'big and bold' as and when the opportunities arise.

As the famed economist John Maynard Keynes once wrote: "It is a mistake to think one limits one's risks by spreading too much between enterprises about which one knows little and has no reason for special confidence... One's knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence."

Summary

Does a focused Qualiport set a bad example for novice investors? Not really. While a concentrated portfolio may not be suitable for all, if you want to make notable long-term progress against the market, it's a necessity.

For starters, having limited berths in your portfolio helps you stick to your investment principles. It also keeps you away from marginal investment decisions and distracting 'side bets'. Knowing you have less than, say, ten stock picks to fill a portfolio certainly ensures a focused mind.

As legendary US investor Warren Buffett commented: "We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it."

Indeed, why on earth would you invest in your fifteenth or twentieth favourite company, when you could put the money towards your favourite instead? It makes no logical sense.

Overall, a concentrated portfolio should inspire patience, independent thinking and thoroughness. Through its own holdings, the Qualiport can hopefully promote these worthy stock market traits to would-be successful investors.

Trading

As previously reported, the Qualiport will take up its option on 187 Johnston Press (LSE: JPR) nil-paid rights (effectively purchasing 187 new Johnston Press shares at 280p) on Wednesday, May 1st.

In addition, over the next five trading days, the portfolio will:

* Sell approximately £2,000 of Emap (LSE: EMA) shares, and;
* Reinvest the proceeds in PizzaExpress (LSE: PIZ).

Thursday's Qualiport will review this 'switch'.

The author owns shares in Carpetright and Johnston Press