He generated 30% average annual returns over 30 years, no down years, and arguably the best hedge fund track record ever. He is Stanley Druckenmiller, recent worth $4bn. A high roller indeed, but we mere mortals can still learn from him.
There is one quote of his which I particularly like:
“The first thing I heard when I got in the investment business, was bulls make money, bears make money, and pigs get slaughtered. I’m here to tell you I was a pig.
I think diversification and all the stuff they’re teaching at business school today is probably the most misguided concept everywhere.
And if you look at all the great investors they tend to be very, very concentrated.”
He put his money where his mouth was. When he and George Soros famously shorted the pound they put 200% of that fund into that trade. That is every penny of their fund, and then borrowed against every penny to double the bet!
A pig investor concentrates his firepower in one area, gorging on one big “best idea”.
First a word of caution – don’t do this at home! At least not quite as aggressively as Mr D.
For most of us diversification certainly does matter – we are often dealing with our life savings, and we don’t want to make stupid mistakes. It is simply a matter of how much we diversify.
This brings us to the benefits of holding funds. One of the main benefits is diversification. In a discretionary portfolio (bought through a stock broker or bank) you might have a mix of 20 to 30 holdings of individual shares and bonds.
In contrast, each individual fund in your portfolio will usually hold between 50-100 individual investments. Even if you held just 3 funds (easy to monitor), the number of underlying shares is probably 150-300 – that’s a lot of diversification.
Can you make do with just 3 funds?
Some people will tell you this is not the right approach but it isn’t either right or wrong - this is simply about your preference, your abilities and your discipline. You can make do with 3 funds. You can even make do with one if you follow the Bonkers approach to investing (more on that here).
You simply need to be comfortable with the volatility that you will likely encounter investing as a pig (investor). For example, you may hit patches where your portfolio falls by 30%. How will you respond?
More to the point how did you respond?
Most investors reading this will have lived through the 1990s, Tech bubble and certainly the Global Financial Crisis of 2007/8. Falls of that magnitude have not been uncommon over the last 25 years.
If you were a little unnerved when that happened in the past that is perfectly understandable. But if you were (or would be) inclined to panic and sell at a large loss then investing with limited diversification and big bets is not for you.
As Mike Tyson said: everyone has a plan ‘til they get punched in the mouth!
Of course, the problem is that a 30% fall can become 60% or even 90%, so you need a part of your plan to deal with this potential disaster.
Having a limit that would trigger a sale – called a stop loss – is one very effective way of dealing with sharp falls. Applying a stop loss hurts – psychologically it is like having your arm broken. But it is far better than being financially crippled if losses mount and your ability to make rational decisions plummets (more on that here).
This is all part of your investing plan. And your plan exists so that you don’t need to think too hard when markets move quickly because you have figured out how you will respond in advance.
ACTION FOR INVESTORS
- Check your investing plan regularly (it’s all part of the discipline of investing)
- Is it fit for purpose? Does it tell you what to do when markets fall sharply?
- If not, take some time to add that into the process.