Diversification in a portfolio

Discussion in 'Strategy Building' started by FuturesTrader71, Sep 28, 2006.

  1. Hi folks,

    Not sure if this is the right forum or not. I'm managing a fund that is growing quite well at the moment. It contains mainly equities, a few FX positions and options. A person who wanted to add funds asked me to put together a diversified portfolio plan. After some research, I thought I would ask those with some experience with this aspect the following:

    1. I use IBD and the Industry Group service to determine the groups and their current ranking. There are 197 groups and they shift slightly from week to week as far as their rank on the list. Out of the various groups/sectors, how many categories would you use to diversify? Are the 10 largest cap groups considered enough diversification? Is there another number that would make sense as far as managing the positions and allotments?

    2. How often would you revise your holdings and the groups in which those holdings belong? Do you check on group performance every month or Quarter and adjust accordingly?

    3. Are there some core groups that you believe have to be a part of the portfolio? For example, does it make sense to find some high quality utilities and include them regardless of where the sector sands relative to the others in performance or setups? If so, which groups/sectors would you include?

    I have done well managing the fund (which also has my money in it), but I'm starting to run into questions that are new to me and require consideration.

    I appreciate any input.

  2. tireg


    The key to diversification is noncorrelation or offset correlation of a significant nature. To understand WHY, you will need to dig deeper.

    The ideas and answers you seek are key in running a portfolio successfully. The ideas are easy to grasp, but the execution of them must 'mesh' with your current perception and approach to the market.

    Topics I would suggest you look into are:
    Understanding Risk - what it really means
    Volatility and its relationship to risk
    Efficient Frontier
    Distributions of returns
    Dynamic system weighting
    Position sizing
    Sharpe ratio
    Inverted sharpe ratio for projected volatility

    Off the top of my list here's a link that talks about the myth of the 15-stock portfolio. Malkiel did a bunch of work on this topic.

    PM me if you want to bounce ideas as you learn more about these concepts.
  3. Interesting article on Efficient Frontier. His final statement makes my brows scrunch to the center of my face. The conclusion is obvious but not practical.

    Let's look at it this way. I have an investor who wishes to see a plan for investing $1MM. My returns on my own funds have exceeded the market due to fundamental and mostly energy plays. However, this investor wants a portfolio that invests significantly in a specific sector of the energy market but then the rest must be diversified or at least not in the same boat.

    Using O'Neil's method and allocating funds to at risk to the top stock or best potential gainer in every industry group (he has 197 groups) might cover this. I also am considering writing calls against his positions in order to generate income with time decay. If the stocks get called, then I have locked in a profit anyway.

    Those are just some of my thoughts. If you have further articles that you feel have provided some depth to your research, please let me know.