Concentrated Investment Portfolios

John Maynard Keynes proposed that investors should hold concentrated investment portfolios.

In 1938 he described the principles he believed should underpin this style of investing. These are:

The Implications Of Concentrated Portfolios

Consider the two possible extremes in building a stock portfolio:

The smaller the portfolio, the greater the likelyhood that its return will differ significantly from the market average.

Investors who have the competence to analyse a small number of businesses in detail and the ability to identify low-priced, outstanding businesses, will be able to outperform the market dramatically . (For example, John Maynard Keynes and Warren Buffett.)

Investors who lack the skill to select suitable stocks and who build a concentrated portfolio will probably underperform the market dramatically. (For example, any number of hopeful small investors.)

The Balanced Portfolio

A concentrated portfolio consisting of several stocks is immune to the risk of total loss should the value of a single holding fall to zero. Investors, however, still run the risk of large losses if each of the stocks in their portfolio behaves in the same way - if the share prices tend to rise and fall in tandem with one another and they all fall when an unexpected, harmful event happens.

Keynes said that investors should hold investments with opposed risks. A simple example of businesses with opposed risks might be a lender and a debt collection agency. Both can prosper in a booming economy. If interest rates rise strongly, the lender’s business will probably worsen but the debt collection agency’s profits could improve.

Alternatively, a stock investor could lessen his or her exposure to risk by investing in commodities or currencies. For example, an investor decides to buy shares in a car battery manufacturer. The batteries are made using lead metal.

If our investor buys lead - either directly in the commodity markets, or through buying shares in a lead mining company - they will lower their risk of loss, because:

Hedge Funds

Gathering together attractive but uncorrelated or opposed investments in a single portfolio is the basis of hedge funds. In his development of the Chest Fund, John Maynard Keynes was responsible for creating one of the world’s earliest hedge funds.