Finweek English Edition - - INVESTMENT -

Re­cently I at­tended an event where one of the speak­ers was Ne­rina Visser, head of Beta So­lu­tions at Ned­bank Cap­i­tal. She made a com­ment that got me think­ing about this week’s topic. She was talk­ing about a stock’s inf lu­ence in an in­dex. For ex­am­ple, BHP Bil­li­ton* has 10 times more weight­ing in the All Share In­dex than all the gold min­ers put to­gether. So a 10% move from all the gold min­ers would only match a 1% move from BHP Bil­li­ton. In other words, the gold min­ers have lit­tle or no in­flu­ence within the in­dex while BHP Bil­li­ton has huge in­flu­ence in the in­dex.

We should view our in­di­vid­ual port­fo­lios much like an in­dex in that each port­fo­lio has a f inite num­ber of shares with spe­cific weight­ings per share. Sure, the num­ber of shares and size within the port­fo­lio can and will f luc­tu­ate over time, but we need to give thought to the makeup of our port­fo­lios and the in­flu­ence of in­di­vid­ual stocks in the port­fo­lios.

I’ve writ­ten be­fore about the core/satel­lite con­struct of my port­fo­lio. I main­tain a core port­fo­lio of ex­change-traded funds (ETFs) that sits at around 44% of my port­fo­lio, a high-risk num­ber. The ETF com­po­nent should be be­tween 50% and 100%, with 100% ETFs be­ing low-risk for a stock port­fo­lio, as the big­gest risk to an in­di­vid­ual’s port­fo­lio is an in­di­vid­ual stock blow­ing up. I add to th­ese ETFs ev­ery month and if the fig­ure drops be­low 40%, I stop buy­ing in­di­vid­ual stocks and only buy ETFs un­til their per­cent­age is back above 44%.

In terms of in­di­vid­ual stocks, how much of a stock does one buy when en­ter­ing a po­si­tion? For me, the rule is that the new stock must make up a min­i­mum of 2.5% to a max­i­mum of 5% of the en­tire port­fo­lio. The de­ci­sion be­tween the low and high num­ber would be based on my as­sessed risk of the in­vest­ment. Sure, I am fig­ur­ing that the risk is man­age­able, but for ex­am­ple, a lower liq­uid small cap would likely only get around 2.5% while a large blue chip would eas­ily get 5%. This means that the blue chip has dou­ble the in­flu­ence in my port­fo­lio than a small-cap stock and on a risk/re­ward ba­sis, makes sense.

But what hap­pens when a stock ral­lies, skew­ing that per­cent­age? For ex­am­ple, When I en­tered into Capitec*, it was 2.5% of the port­fo­lio but it has since gone up al­most ten­fold and, while the rest of the port­fo­lio has done well, Capitec would now have around 11% of the port­fo­lio. That I can live with, but if it had started hit­ting 20%, I would’ve sim­ply sold a few to re­bal­ance to a more weighted risk pro­file. Now, I hate sell­ing, but hav­ing a fifth of my in­vest­ment world in one stock is a huge risk.

I also look to man­age the risk by only hav­ing two (or at a push three, but I haven’t had that sit­u­a­tion in many years) stocks from any sec­tor in my port­fo­lio. That is in part about man­ag­ing sec­tor-spe­cific risk but it is also be­cause if I can’t de­cide which are the two best stocks in a sec­tor then, frankly, I haven’t done my home­work well enough.

All in all, it means that I have a bal­anced port­fo­lio with­out too much risk in one stock or sec­tor, but it also en­sures that a win­ning stock will pos­i­tively ben­e­fit my port­fo­lio.

Si­mon Brown heads ju­s­, a free re­source of f inan­cial in­for­ma­tion and in­vest­ment ed­u­ca­tion.

* The writer owns shares in BHP Bil­li­ton and Capitec.

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