A Million Thanks, “Critical” comments and Portfolio Diversification kcchongnz

Thanks for a million for all the kind words in my thread “Thanks a million” here.

http://klse.i3investor.com/blogs/kcchongnz/82003.jsp

All these while, there are many of you whom I know have been motivating me to continue writing with the positive remarks. I really appreciate them deep down my heart although I did not express my thanks in the blog for certain reasons. There are many whom I do not know too who are equally supportive. I hope you can continue to read my articles and provide me with constructive feedback. It is these constructive feedbacks that curbed my overconfidence and made me cautious about investing in some of the stocks which I personally wrote about before such as Coastal Contracts (oversupply of oil vessels), Elsoft (just a contract service provider), and Tongher (high USD denominated loan). There are many people out there who know a lot more than us in some companies and industries.

So people, don’t get mad with other people who provide alternative views about the stocks you love, especially if they provide some facts and analysis. It may be good to curb your overconfidence, which can be very bad in investment.

Here I would like to deal with the couple “critical” comments on my thread on “Thanks a million”. Thanks for a million on these comment. You see, it motivates me to write again. The comments are:

Posted by paperplane2 > Aug 28, 2015 02:23 PM | Report Abuse

http://klse.i3investor.com/servlets/pfs/42499.jsp

Posted by paperplane2 > Aug 28, 2015 02:24 PM | Report Abuse

KCCHONG portfolio return 3% only, it proof tht Value investing will failed according to mkt also!

The first comment exposes my portfolio and the second comment says value investing, which I have been propagating, fails. The author of the comments went on with further comments in another thread of mine, scared that I didn’t see his previous comments as below.

Posted by paperplane3 > Aug 25, 2015 09:40 PM | Report Abuse

Kcchong, your elsoft also Holland now!

Posted by paperplane3 > Aug 25, 2015 09:41 PM | Report Abuse

When tide away, we know who is master and who is not, hahahahaha

Posted by paperplane3 > Aug 25, 2015 11:56 PM | Report Abuse

Seems like value investment d9nt work this time

Here I assume the writer with the suffice 2 and 3 is the same person. I did commend negatively on stocks other people interested in such as V.S, Masteel, MTDACPI, Success Transformer, London Biscuits, KNM, even Inari. I even commented on the stocks ColdEye had before which appeared to me were not good companies. All the time, I provide my analysis and reasoning, properly articulated with facts and figures, all for sharing and discussion about investing. They were never meant to criticise anybody personally. Of course I could be wrong sometimes.

So where are your analysis, facts and figures about your sweeping statements above that value investing doesn’t work? Is it purely due to the fall of the share prices due to the overall market conditions? If so, I am afraid that you may not understand what value investing is. I would encourage you to read these posts of mine below to learn about what is value investing, and why it works in the long term, but not necessary in the short term:

http://klse.i3investor.com/blogs/kcchongnz/53835.jsp

http://klse.i3investor.com/blogs/kcchongnz/50988.jsp

Nevertheless, let me take this opportunity to discuss with you one concept of value investing; portfolio diversification based on the “exposure” of the “failure” of my portfolio.

The setting up of the “portfolio”

The portfolio appended by the person critical about it can be found in this link here:

http://klse.i3investor.com/servlets/pfs/42499.jsp

There are a total of 25 stocks in the portfolio. They were actually “formed” by elimination of the three portfolios of mine which were posted by Tan KW, a regular contributor in i3investor. The elimination process was well documented in my posts below which I would like to share with you again:

http://klse.i3investor.com/blogs/kcchongnz/67653.jsp

http://klse.i3investor.com/blogs/kcchongnz/68009.jsp

http://klse.i3investor.com/blogs/kcchongnz/68248.jsp

http://klse.i3investor.com/blogs/kcchongnz/68591.jsp

http://klse.i3investor.com/blogs/kcchongnz/68735.jsp

http://klse.i3investor.com/blogs/kcchongnz/68905.jsp

You can see from all these posts the portfolios were used as sharing and discussing about the rationales and process of value investing rather than the outcome of return of the portfolio. Yes, I have invested in all of them before, but I don’t start to invest in from 1^st January 2015. You have no idea of when did I buy those stocks, what price did I pay and what stocks I am still holding. You would know the rationales I bought those stocks, approximately what prices I have paid with all my analysis and reports on them in i3onvestor if you were to read them. But they were all purely for sharing and discussing about value investing.

Portfolio return

The writer of the comments implied that value investing won’t work, failed miserably, because it only returned 3% this year as shown in his comments above. Is value investing talking about 9 months investing horizon? Failed? In the short-term of 9 months? And compared with what?

The portfolio consists mainly of small to mid-capitalization stocks, which normally would decline more than the blue chips in market turmoil. As at to date, the broad market, unfortunately declined by 13.4% this year, while the portfolio, with 2 deadly company warrants of more than 30% loss, still returned 1.88% as shown in the link. I am pretty happy about it, even in this short-term volatility.

What if you compare with investing, or rather speculating in Asdion or its warrant at their peak price of RM1.57 and more than 70 sen this year?

http://klse.i3investor.com/blogs/kcchongnz/80930.jsp

Oh yes, that portfolio of 25 stocks were not meant for the stock contest going on in i3investor. It was never meant to as mentioned in the above portfolio set up process, and so don’t compare with yours.

I do know some people who bet on export stocks are making very handsome returns year to date, but they are far few and rare. Don’t forget that the same people/person could have loss big time when they bet on plantation stocks or oil and gas stocks the last few years.

This shows the power of diversifications which I would like to talk about here.

Portfolio Diversification

Many academicians do believe there is a kind of free lunch in the market, i.e. in portfolio diversification. The popular adage of "Don't put all your eggs in one basket" is very much suited for investing in the stock market. It advocates diversification, a technique that reduces risk by allocating investments in a number of stocks in the portfolio. Ideally the stocks chosen should be spread over different industries that would each react differently to the same event.

Theoretical background

Risk and return, and diversification is a major topic in finance and investment. As the number of stocks in the portfolio increases, the variation of return reduces sharply initially as shown in Figure 1 below. Studies and mathematical models have shown that maintaining a well-diversified portfolio of about 20 stocks will yield the most cost-effective level of risk reduction as shown in the figure below.

Figure 1: Reduction of idiosyncratic risk

Modern Portfolio Theory by the Nobel Laureate Harry Markowitz has shown that when you have stocks or other assets that have low correlations together in a portfolio, you may be able to get more return while taking on the same level of risk, or the same returns with less risk as shown on the efficient frontier in Figure 2 below. The less correlated the assets are in your portfolio, the more efficient the trade-off between risk and return.

Figure 2: Efficient frontier

Stocks diversification won’t ensure gains or guarantee against losses but strives to smooth out unsystematic risks of companies in a portfolio which are not perfectly correlated so that the positive performance of some companies will neutralize the negative performance of others.

Making sense of portfolio diversification in real life investing

“Diversification is for people who don’t know what they are doing.”        Warren Buffett

The question is are you that good as Warren Buffett who knows the businesses he intends to purchase that well, or do you have the financial clout of Warren Buffett who could take over the management of the companies he invests in if required? Buffett does make mistake too and he admitted it in all the shareholders’ meeting, the purchase of Tesco is one of them. In fact, Buffett owns several companies in different industries with different risk profiles.

Most value investors adhere to portfolio diversification because of humility, as a defence against uncertainty. It is an essential for investment success. Humility allows value investors to be aware that they are far from being invincible, and that they can be wrong at times.

“I like the idea of owning a number of stocks. Warren Buffet is happy owning a few stocks, and he is right if he is Warren….”          Walter Schloss

Smart diversification in stock investing entails investing to reduce risk, without watering down returns. It means not diversification just for the diversification’s sake. It means:

• Not buying a mutual fund/unit trust which is tracking all the stocks in the market, or 10 different unit trusts from the same or different unit trust companies. This will only produce return below the market returns after all management expenses and transaction costs.
• Not owning 100 stocks for the same reason above. It is hard to keep track on so many stocks.
• Own just about 10 best stocks in terms of quality and price versus value of different industries for most retail investors, more for those, maybe 20 stocks, who have tens of millions of fund to invest in.

That is exactly what I am trying to do, to have a diversified portfolio, but not so many as 25 stocks in the portfolio. I am happy that in this short span of 9 months, the return of the diversified portfolio is still satisfactory at the positive territory despite the sharp fall in the broad market of 13.4%, especially for the lower liners which I invested in. In the longer term of two to three years, which is still not long enough, when those stocks were first purchased, the returns were much better. Value investing still seems to work for me, even in the short-term with high market volatility.

Conclusions

Knowing that the world can be uncertain, most value investors hold a diversified portfolios. Generating superior return is certainly an important aim, but safeguarding assets and protecting them from losses is just as crucial. In that sense, diversification is a natural course of action. And portfolio diversification appears to be the only free lunch in investing.

Many people invest in the stock market with the hope of building long-term wealth but not many of them are embarking on value investing. It is a pity as value investing is plausible, and it had worked in the past, and continue to work for various reasons as shown in my links above.

For those who wish to start to learn about value investing, please contact me at

ckc14training@gmail.com

K C Chong