A letter a day!
Letter #04 2004
1.As the cash is invested, portfolio concentration will rise.
“The logical extension of this line of thought is that Nomad’s portfolio concentration has at times been too low. And if it has been too low at Nomad, what has been going on at the large mutual fund complexes with many hundred stocks in a single country portfolio? Apply the Kelly criterion, and the average fund manager would appear to have almost no clue as to the likely success of any one idea. In our opinion, the massive over diversification that is commonplace in the industry has more to do with marketing, making the clients feel comfortable, and the smoothing of results than it does with investment excellence. At Nomad we would rather results were more volatile year to year but maximized our rolling five-year outcome.”
2.The more stocks you own the less you care about each one individually. Attention paid to corporate governance, capital allocation, incentive compensation, accounting, and strategy has to be diluted as the number of stocks rises.
“When over- diversification becomes the industry norm then in aggregate investors risk failing to police bad corporate behavior. Would fund managers be so liberal with dysfunctional management if the holding was 20% of the portfolio rather than 0.2%? Ofcourse not. Perhaps some of the scandals of the last few years would have been averted if fund managers had been more proprietorial about their holdings.”
- There are only two reasons companies behave well. Because they want to, and because they have to. Your preference should be to invest in those that want to.
4.Nomad partnership limited, at their office kept a list of companies under the title ” Super high-quality thinkers” This list consisted of 15 businesses which according to nomad partnership was the compounding machines. However, this companies were not the same as Nomad’s portfolio. The reason is price.
“In paying up for excellent businesses today, investors are already paying for many years growth to come, in the hope that, as the saying goes, “time is the friend of a good business”.
5.On growth Vs Value
“We won’t end the debate here but, so that we all understand, our definition is that a business is worth the free cash flow that it can be expected to generate between now and judgment day, discounted back at a reasonable rate. Period. Growth is therefore inherently part of the value judgment, not a separate discipline. “
6.There is no reason why business values and share prices should move hand in glove. You should expect that there will be a time when prices, and your performance, significantly lags the performance of our underlying businesses. It is then when you should be contrarian and invest more.
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