Security selection is based on our philosophy that diversification is the key to long-term investment success. Whether the given portfolio is aggressive, conservative or somewhere in between, diversification will help prevent investment disasters. Conversely, and almost as important, is to avoid over-diversification. The latter can lead to mediocre results that do not justify the effort.
Portfolios are diversified in two basic and interrelated ways. First, initial positions in a selected security are limited to five percent of the total portfolio value. This would result in 20 equity positions, but since the process is evolving, there will be more or less positions at any given time. A position of less than five percent may be initiated depending on the particular portfolio’s risk tolerance.
Academic theory argues that a portfolio need contain only 13 securities to be statistically diversified if the securities are properly diversified by industry and economic sector. The addition of securities does not significantly reduce risk further.
Secondly, portfolios are diversified by industry. No attempt is made to mirror the industry structure of the Standard & Poor’s 500 index; this would lead to over-diversification. The selection process concentrates on the strongest industries in terms of their relationship to the economic cycle. Various industries react differently during the evolution of an economic cycle.
The ongoing investment process is enhanced by the continual review of securities and portfolios. Individual securities are closely reviewed to make certain that they continue to meet original fundamental and technical parameters. Additionally, portfolios are monitored to ensure that the current strategy is intact and that proper diversification is in place.
The sell decision is critical to successful investing. The decision is a function of risk versus reward. Has the investment continued to meet original expectations? This must be viewed in terms of the company’s internal growth as well as stock price performance. Stocks that do not meet expectation will be liquidated.
