With talk recently about improving a portfolio by adding new assets, I want to talk about the opposite.

Can removing assets improve your portfolio?

Let’s start off with a sports analogy from one of the greatest basketball teams ever.
The 2015 Golden State Warriors were a great basketball team. But in the championship they fell behind early.

Their coach then tried something different. He removed the “center” position from his lineup and replaced him with another forward.
This line up was small. It didn’t have a “big man” as all traditional lineups do.

But removing the biggest player on the court, and playing two small forwards instead, made the team unstoppable and they easily won the remaining games to win the championship.
The new starting group was so unstoppable it garnered the nickname the “death lineup”. The next season the Warriors won more games than any other team in basketball history.

All by removing a key piece of most teams, and replacing them with “more” of an existing type of player.
Now there were trade offs to this strategy.

Rebounding might go down. The quality of interior defense might drop.

But these loses were more than overshadowed by the increases in offensive performance and in the versatility of their perimeter defense.
The Warriors improved by removing an entire skillset from their lineup in order to have more of one they already had.

Portfolio construction is similar. Most portfolios are full of “diverse” assets. But sometimes diversity drags down the portfolio instead of enhancing it.
Do you need a fund for every sector of the market?
Do you need a fund for every possible factor or risk premium?
Do you need to be exposed to every single global market?
Do you need to hold every commodity?
Do you need to hold every type of bond?
It all sounds good on paper, but so does having a 7 footer to defend the rim in basketball.

However what’s often more valuable to a basketball team is removing the 7 footer, and instead putting more outside shooting and a flexible/switchable defense on the floor.
Placing 4% of your wealth in the latest factor sounds like a good idea on paper. You need shot-blocking in your portfolio right?

But there’s only so much space on the floor just as there’s only so much wealth to invest.
That space in your portfolio probably would be better utilized by just owning more of the S&P 500. or more bonds or more gold.

Yes, in some environments, you might miss the new trendy bull market.
But in the long run, focusing on fewer positions that play well together (correlation), share the ball (rebalance), minimize turnovers (volatility), while all still providing scoring (arithmetic return) will lead to more wins (geometric return).
So take a look at your portfolio and ask yourself if you have any positions that should be removed to increase your core holdings.

Your path to an investing championship may not come from adding more investments, but from consolidating down to less.

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More from @breakingthemark

25 May
Hedge funds, are the spices of the investing world.

By themselves, they often don’t taste spectacular, but when you mix them with other ingredients they improve the flavor of other foods.
Many specialized funds do not actually produce much, if any, return. But they are often negatively correlated to the market.

This means that adding them to a foundational “beta” portfolio improves their geometric return by lowering portfolio volatility.
What bothers me though is spices have recipes, which tell you how much spice to add to what amount of the other main ingredients.

Hedge funds don’t. How much hedge fund do you mix with the S&P 500?
Read 8 tweets
15 Apr
I think the real scarce resource in Bitcoin isn’t created by the the 21 million coin limit, but by the 7 transactions per second limit.

The real money will be in controlling that resource.

A thought experiment...
Let’s assume Bitcoin is successful from a store value/digital gold perspective. People will use it like a savings account or investment account.

Suppose there are a billion wallets, a touch more than 10% of the global population (of course organizations will have wallets to).
Since bitcoin is for savings, imagine people only need to make a transaction once a month.

Invest new savings or pull out past savings to purchase something. Similar to what people use long term savings/investing accounts today.
Read 18 tweets
31 Jan
Some of the takes lately on short sellers have been exaggerations of reality in my opinion.

Short sellers serve an important roll in the markets. They dampen out volatility because they often cover when prices fall rapidly to cover their positions, and sell on rapid...
.., unusual price increases on the way up. Usually this improves market stability.

Others have pointed out they also ferret out fraudulent companies like Enron and Worldcom. All true.

Lately, I have seen the following companies being short squeezed described as frauds:

Read 11 tweets
17 Dec 20
I just re-read Bernoulli’s 1738 paper “Exposition of a New Theory on the Measurement of Risk” which is the foundational paper of Expected Utility Theory.

It’s Amazing

It’s so wildly different than EUT that its hard to believe this was its beginning.

Let’s see if you agree.
The paper isn't about utility. It’s about expected value.

Bernoulli used the utility concept to get the reader to abandon the traditional view of expected value(arithmetic average), and then used it to derive the equation for valuing risk.

The final equation doesn’t use utility
He starts out the paper identifying that tradition evaluation of risk come from expected values, which are calculated with the arithmetic average.

Notice the rule here in italics is about expected values.
Read 30 tweets
14 Dec 20
If everyone is society optimized for arithmetic return, or linear utility, then society would grow wonderfully at first. Society's geometric return would be high. Some people would win big, some would lose big, and the average would be good because many are involved.
Through time though, many people would get unlucky by losing a few times in row and would fall out of contributing because they don’t have much capital/resources/access any longer to help. So now the number of contributors to society’s growth is smaller.
If people keep basing decisions on linear utility, with fewer and fewer winners each round and more and more losers, a funny thing starts to happen. Probability says society stops growing as more people fall out of the game, leaving fewer people capable of creating growth.
Read 7 tweets
4 Jul 20
There are two side to the Kelly Criterion which I think often get equated as the same when they really are not.

Traditional Kelly betting is about limiting your exposure to a risky bet. The bet in question is usually a "bet" in that when you lose, you lose everything you expose.
So you scale back and don't risk everything. Most casino games fit this description as do some financial instruments like options.

The optimal leverage here is less than 1. You want to hold cash on the side to buffer the future losses.
But standard investment assets, don't work this way.

I showed here, that individual stocks are effectively full Kelly bets.

Just buying one stock is the appropriate "size", as they have an optimal leverage of 1.

Read 7 tweets

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