Recently, I was lamenting the lack of female representation in investment management. Then in conversation, a friend reminded me of this insightful interview with Lisa Rapuano, who worked with Bill Miller for many years, and currently runs Lane Five Capital Management. The interview touches upon a number of relevant portfolio management topics. Rapuano has obviously spent hours reflecting and contemplating these topics. A worthwhile read!
“I think that most investors spend way too much time talking about stocks and way too little talking about portfolio construction.”
Expected Return, Diversification, Sizing
“I’ve learned that you have to have a lot of different risk-reward profiles in your portfolio. You’ll have some things you think can go up 25% but you don’t think can go down very much. You’ll have things that can go up 50% but might go down 30%. Others can go up ten times, but may go down 75%. I try to manage the proper mix of all those. You just can’t have a portfolio where you say everything is priced to have 25% upside with little downside. What’s going to happen is that you’re going to be wrong about two of them and they go down 50% and you’re screwed because nothing else has enough upside to make it up.”
“A word on concentration. You can take it too far. I know there are manager out there who get enthralled with the Kelly Formula and start putting out 25% or 50% positions because this one is REALLY the best. That just defies common sense. Anyone can be wrong, and any outcome can happen, even if it seems low probability. Keeping a minimum 20 name portfolio with about 5% as a normal position keeps you from making those kinds of mistakes.”
I thought the idea of maintaining a variety of expected returns in one’s portfolio was particularly interesting. People frequently discuss diversification in types of ideas/assets, but not often diversification in expected return profiles.
Also, there is wisdom in her caution against blindly using the Kelly Formula (even if you don’t agree with her advice for a 20 position portfolio). Blindly following any rule is simply a bad idea. Putting 25-50% of your portfolio into one security can be pretty painful if/when you are wrong (which happens occasionally even to the best investors).
However, that doesn’t mean one should never put 25-50% of the portfolio into one position. The important takeaway here is maintaining flexibility, being prepared (especially mentally) for the possibility that you could be wrong, and having a “break the glass” contingency plan just in case the worst materializes.
“We tend to run about 70-100% net long, with a maximum of 100% gross long. Since we run a very concentrated long-term fund on the long side, we believe that going over 100% gross long isn’t prudent.”
Concentration (and thus high portfolio asset correlation) and leverage is a potent combination – the result is likely in the extremes of (1) homerun good or (2) disastrously bad.
Time Management, Sizing
“A new position has to be compelling enough to put at least 3% of the fund in, or it’s not worth dabbling in.”