3. Be Concentrated, Don't Overdiversify

  • Over-diversification is incredibly destructive. Exceptional investments are rare, so don't dilute great investments with average ones.


There are two main forms of stock investing:

  • Passive: own all the stocks in an index (such as the S&P 500) rely on the whole index going up to generate returns

  • Active: select a small number of individual stocks to buy, based on company and stock analysis.


The explosion of passive investing over the past decade has largely been destructive in our opinion.


Passive managers often claim that “less than 50% of active managers outperform their benchmarks”. That statistic is enormously misleading. Remember two things:

  • Most active managers claim to be ‘active’, but in reality they are actually passive. Funds aren’t active if you own more than 50 stocks. If you own more than 50 stocks your returns will largely track the index anyway. You will find mutual funds claiming to be ‘active’ are in fact simply expensive passive trackers

  • If you own a passive investment you are guaranteed average returns at best. Its simple math. If you own all the good stocks and all the bad stocks, then your returns can’t be any better than  the market itself (which is the average return). In fact they’ll typically be slightly worse, as you’re still paying a fee

There are many active managers who have demonstrated that it is possible to outperform the market over a long period of time. Great investments are rare- so when we find them, they should be decisively backed. Diluting great investments with poor ones will result in average returns.


1) Markets are driven by humans. Humans are not rational, nor efficient. For passive investing to work, we must believe markets are efficient- what is known as the Efficient Market Hypothesis (EMH). For this to be true, market participants (people) must act rationally and respond to news flow and information in a logical manner. We know neither of these things are true. We have seen thousands of examples historically of wild asset mispricing driven either by fear or by greed, and we will continue to see many more in the future. Think tulip mania, or the dotcom bubble, the financial crisis or even bitcoin. 

2) The market is an aggregation of all share prices and therefore the average of market participants. Investing passively, you will at best earn those average returns. Careful and prudent investors hold a concentrated number of great investments without diluting their portfolio with poor or average ones. In this manner it is possible to outperform consistently. 


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