Seth Klarman on Portfolio Construction [Thread]:

1. You diversify away most of the diversifiable risk by having a portfolio of 20 or 25 positions.
2. You should be able to tell a great investment from a good investment, so there is no sense in having the same size position with your best idea and your 100th best idea.
3. A position is defined as the total investment in a company’s securities (which could span different asset classes).
4. A concentrated position is a ~10% position
4.1 In the 5.5 years from Oct 95 to Apr 01, Baupost only made two 10+% investments, and five 7-10% investments.
4.2 We would own a 10% position in a distressed debt, where the assets were very safe – either cash or receivables or where we could count on getting our money back, and where we saw almost no chance of principal loss over a couple of years and a chance of a very high, 20% plus.
4.3 We would not own a 10% position in a common stock that was just plain cheap unless we had a seat on the board and control, because too many bad things can happen.
5. Most of the time, our most favorite ideas have 3%, 5%, 6% positions.
6. Position size will increase when a cheap position becomes much, much better a bargain or when there’s a catalyst for the realization of underlying value.
6.1 A catalyst gives you a much shorter duration on the investment and greater predictability that you will in fact make money on that investment and aren’t subject to the vagaries of the market and the economy and business over a longer period of time.
7. New inexperienced managers will have some 20% positions which might even be correlated, that’s absurdly concentrated.
8. 1% positions are too small to take advantage of the relatively few great mispricings that you can find.
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