A Whale in the Aquarium Causes Problems

Every now and then you will come across a once in a lifetime investment - that not only feels too good to be true, but also has all the hallmarks of being a true winner.

On these occasions, it is very hard not to end up in a situation where one share dominates the rest of your portfolio - and if that share goes on to do well, then of course this is a great result - but the focus on a single share will increase it's dominance on overall performance.

These days my largest holdings (based upon current market values) are as follows:

• 19.2% in a market index (FTSE 100)
• 18.9% in a single share (hopefully a once in a lifetime winner)
• 6.6% in a market index (FTSE 250)
• 3.6% in a single share
• 3.3% in a single share

When it comes to investing there are two schools of thought:

1. Diversify across a mix of shares, ideally via index trackers
2. Focus on high-convention bets where you believe there is low risk and high reward

In reality, many of the best investors use a mix of enough diversification - but with larger high-conviction bets layered in.

And my philosophy here is that you do generally want diversification, but you can on occasion make high concentration bets so long as the rest of your portfolio can mop up the mess if it all goes wrong.

That means (a) not going overboard on the concentration (I am probably pushing the limits at around 20% of the portfolio), and (b) taking the risk into account across the rest of what you are doing.

If it goes wrong then there will be consequences, but if it goes right then you will get the opportunity to achieve out-sized returns.

In the case of my high concentration in a single market index, this has gone well - I felt that there was low enough value and enough quality in the FTSE 100 to focus heavily on this, at a time when everyone else was fawning over the S&P 500.

So far that has paid off and proven by undenial genius.

On the other hand my other riskier high conviction bet on a single share is perhaps misleading, because the percentage of total holding value figures above exclude the fact that I am carrying a hefty loss on that holding.

And so here, we see an example of where the market has not yet appreciated my undeniable genius.

But here you see the problem with high conviction bets - for in all scenarios I will point to my undeniable genius, and not to the reality of the situation at hand.

But how big an impact does this have on my overall returns?

On an overall basis, I don't have too much to get upset about, with an annual return over the last two years of around 8% - whilst this is not spectacular, it is not terrible either, and within this return there have been mistakes made and lessons learned along the way.

My focus on the FTSE 100, however, has a running annual return of 19% over the same period - but that high conviction bet on a single share current runs at an annualised loss of 16.5%.

And those quick at maths will realise that with the two currently contributing a fairly similar share of my overall portfolio value - this means that the capital invested in the single share was greater than that invested in my primary index of focus.

And as a result of this, once I extract these two dominant shares from my overall portfolio, and recalculate those levels of returns - that satisfactory 8% return gets replaced by a much better 17%.

And so it is that without my big conviction bet on that single share, I would probably have returns in the region of 18% (aided by both the FTSE 100 index performance and the mix of smaller investments I have across the portfolio).

So is this a problem?

Well - in terms of returns yes. Instead of getting that 18% return - which I would be very happy with by the way, I am only getting around 8% annualised return. 

And for those not so quick at maths, this is less.

Getting back to breakeven on that big bet would be transformation in terms of my returns - and in this sense (as the title suggests), a whale in the aquarium does indeed cause problems.

So why did I do it?

At the end of the day, my analysis suggested that the big conviction bet was a one off opportunity that rarely comes around. In terms of price to underlying performance none of the other shares I have looked at came close in terms of potential return - and the reasons for the weak share price were clear and understandable.

I still hold the believe that my big bet will become my greatest ever investment - but for sure, a whale in the aquarium causes problems.