Is Diversification A Defense Against Ignorance?




There’s  a train of thought among people that concentration is the way to earn out-sized returns in investing. Buffett probably helped popularize this idea by focusing on his “twenty punch card rule”, citing that diversification is really a guard against ignorance. Charlie Munger is as much a proponent of concentration as Buffett, and is famously known for saying that 3 stocks is enough.

Although it may sound appealing, I think 99% of investors are better off with a reasonably well diversified portfolio of common stocks (15 – 20) than let’s say a portfolio of 5 stocks. One can only have conviction to hold on in persistent market declines by way of research that is both borne out of experience and hard work.

Malcolm Gladwell often takes about the 10,000 hour rule, and the same applies to investing. The challenge is that one not only needs to understand a single business well, but to be able to look at it in the context of the big picture.

Investors cannot simply focus on single trees, and have to be weary of the going-ons in the forest as well. This requires concentrated effort and time to pull off – along with a sound framework.

My own personal feeling is to embrace that there are really many things that we do not know anything about, much less control. Diversification is simply a way of me saying that there are plenty of unknown unknowns.

¨We are obviously only going to go to 40% in very rare situations – this rarity, of course, is what makes it necessary that we concentrate so heavily.

When we see such an opportunity. We probably have had only five or six situations in the nine-year history of the Partnership where we have exceeded 25%..“

Buffett Partnership Ltd 1966


What about Activist Investors?

Activist fund managers like Bill Ackman of Pershing Square Management, Carl Icahn of Icahn Capital Management and Jeffrey Ubben of ValueAct Capital run extremely concentrated portfolios.

Their top 5 positions often compromise of more than 50% of their entire portfolio. But one thing to bear in mind is that unlike us, these investors areactivists. Most investors on the other hand, are minority shareholders, with very little say over managerial discretion.

Taking an activist stance allows investors to become the de-facto catalyst, bringing light to undervalued situations, liquidating positions to return cash to shareholders, re-vamping stagnant management and unlocking the “value” within. This was a common tactic of the early day Buffett partnership, where he often took positions on boards to jostle of change. This is in my opinion why activist investors can often do away with the diversification that most of us have to contend with.


Tracking 13-F of Activist Investors

One extremely efficient way of sourcing ideas is to track the 13-Fs of activist investors. The nature of how their portfolios are constructed means a good deal of research has taken place before an activist investor decides to commit. Furthermore, the presence of activists means that change takes place quicker than slower.

This is not to say that they will always be right; there have been well recorded blow-ups such as Bill Ackman’s failed attempt at a turnaround in JC Penny. Their overall track record has shown however that in aggregate, activists are more often right than wrong, and that their ideas are a good source of ideas that will out-perform the market.


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All views and opinions articulated in the article were expressed in Jun Hao’s personal capacity and do not in any way represent those of his employer and other related entities. Jun Hao does not own any shares in the companies mentioned above.

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