Nurturing a concentrated portfolio could be the key to creating alpha

First Water

First Water

For the seasoned and experienced investor, a concentrated portfolio can give that extra oomph in their search for alpha.

By Ricky Kirpalani

Every investor has their own investment strategy. These investment strategies can range from a highly diversified portfolio to a more concentrated portfolio, where a larger percentage of investments are directed toward fewer companies or industry sectors. While there is no one-size-fits-all approach, the key factors to consider are one’s financial goals and the amount of risk one is willing to take. Although there are some investors that are particularly risk averse and prefer to have a broad-based ownership in 40-50 companies, I believe that strategic concentration in around 12-18 companies with varying weightages is one of the keys to creating long-term alpha. At this point, I would like to strongly emphasis that I reserve the right to be wrong and that increased concentration may lead to concentrated risks as well as losses. This is a case of Caveat Lector (let the reader beware).

A Concentrated Portfolio is about knowledge-based investing

In the words of Warren Buffet, “Diversification is a protection against ignorance.” Even today, just 4 stocks make up c.70% of his Berkshire Hathaway portfolio. Choosing a concentrated portfolio is the mark of an experienced investor who has the courage of his conviction. This conviction is built up through a deep understanding of the selected companies and their underlying intrinsic values, and is a necessary asset, especially when the market goes against you as it often does.

The case for a concentrated portfolio
For the seasoned and experienced investor, a concentrated portfolio can give that extra oomph in their search for alpha. After all, if you have 30-40 stocks in your portfolio, how are you really different from the index?

If a fund has 30 equally positioned investments, each one represents a stake of 3.3%. Even if that investment triples, its impact is muted by its size, adding just 6.67% to the value. If we compare this to an initial position of 15%, we see that a similar increase adds 30%.

In addition, having fewer positions allows the investor the time to study the company as well as react to new information. By monitoring too many sectors, companies, and relevant news, investors can often spread themselves too thin.

Concentration in a long-term serial compounder – the Holy Grail of investing
Prior to setting up First Water Capital, I had been mainly managing a personal pool of capital and have long been a proponent and beneficiary of a concentrated investment approach.

One investment example that comes to mind is Polyplex, which at one point represented more than a quarter of the portfolio and played a significant contribution to the AUM growth.

Some of you may be wondering what Polyplex is and why anyone would buy such a concentrated position. Polyplex is a flexible packaging company and, therefore, a proxy play on the highly valued FMCG sector. Flexible packaging is widely used, for instance, to wrap your crisps and confectionery, as well as in many applications beyond food. Essentially, this stock turned out to be one of the Holy Grails of investing – a long-term serial compounder which was, both, a value and a growth play.

Polyplex, at the beginning of 2000s, went from a small Indian player to a top 10 global player in its space. Even as it currently stands, the space is growing at c.4-6% globally and at c.10-12% in India. The Company is a generally debt free, an Indian multi-national with factories across the world, as opposed to simply being export driven. It has multiple Blue-Chip clients and on top of all that, was available, until recently, at less than book value. This to me was a compelling concentrated investment thesis.

These traits, along with other gleanings, led me to build up my position with so much conviction that it became around 25% of the book. And fortunately, it paid off.

(Ricky Kirpalani is the Lead Sponsor & Investment Advisor at First Water Capital. Views expressed are the author’s own. Please consult your financial advisor before investing.)

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The views expressed are the authors own. Please consult your financial advisor before making any investment decisions.


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