Money Australia – July 2017

KEEP MONITORING

Another practical tool you can use is a matrix, like the

one in the table below. It lists the stocks in your port-

folio on one axis and various risks on the other. Then,

next to each corresponding stock/risk box you indicate

whether the given risk factor would be a positive, neg-

ative, neutral or “don’t know”.

There are several benefits to this approach. First, it

forces you to confront the various risks your portfolio

faces. This is especially timely when we’ve been in

relatively calm financial seas recently. Second, it encour-

ages you to thin k of as many risk factors as possible and

go through the healthy thought experiment of consid-

ering their impact on each of your investments. Of course,

this involves a high degree of informed estimation. Third,

it allows you to see which risk factors you’re most exposed

to. You might also make some improvements to the table

(for example, you may be able to visually represent the

weightings in each stock by colour coding or even

changing the size of the rows).

Importantly, this approach is not about predicting risk.

It’s about making sure you’re prepared for the outcome

of a wide range of events and ensuring that you’re not

going to suffer financial ruin from any one of them.M

1. Mining stock A (60% underpriced)


2. Mining stock B (50%)


3. Mining stock C (40%)


4. Supermarket retailer A (35%)


5. Medical stock A (35%)


6. Medical stock B (30%)


7. Mortgage broker A (25%)


8. Medical stock C (20%)


9. Specialty retailer A (20%)


10. Infrastructure stock A (15%)
    A concentrated portfolio constructed from this list
    might look like the chart at right. The two key aspects
    of this portfolio are that higher allocations are made
    to the more underpriced stocks but that risk factors are
    carefully taken into account.
    For instance, you can see that Mining stock C and
    Medical stock C have been omitted altogether, even though
    they’re more underpriced than stocks below them on the
    list. That’s because underpricing is no guarantee of a good
    outcome. Every stock has risks and you don’t want to be
    over-exposed to any single risk factor or sector.
    As Thorp explains: “Betting too much, even though
    each individual bet is in your favour, can be ruinous”.
    As a concentrated investor, my top priority is avoiding
    ruin (losses from which the portfolio is unable to
    recover). Part of my protection at this point is holding
    a hefty amount of cash. Relative to a more normal
    level of 5%-10%, I’m currently in the 15%-20% range
    given recent favourable market conditions.

Underpricing is

no guarantee of

a good outcome

SAMPLE PORTFOLIO

Mining stock A

Mining stock B

Medical stock B

Mortgage broker A

Cash

5-10 other

stocks

Infrastructure stock A

Specialty retailer A

 







  



 Supermarket

retailer A

Medical stock A

RISK FACTOR MATRIX

RECESSION INFLATION PROPERTY CRASH MAJOR TERROR INCIDENT

Westpac Negative? Negative Neutral

BHP Billiton? Positive? Neutral

Woolworths Neutral Neutral Neutral Neut./Neg.

Computershare Neutral Positive Neutral Neutral

Newcrest? Positive? Positive

QBE Insurance Neut./Neg.?? Negative

Greg Hoffman is an independent financial educator,

commentator and investor. He is also chairman of Forager

Funds Management.

Disclosure: Private portfolios managed by Greg Hoffman

own shares in BHP Billiton and Computershare.