Laughing Water Capital: Real Diversification Means Part Of Your Portfolio Will Not Be Working

Johnny HopkinsLaughing Water CapitalLeave a Comment

In their latest 2021 Year-End Letter, Laughing Water Capital discuss why real diversification means part of your portfolio will not be working. Here’s an excerpt from the letter:

On size, I continue to think that we are best able to flex our competitive advantages as an investment partnership in the smaller cap sections of the market, despite the broad brush strokes of factor investing, which are currently a challenge for small caps. On growth, while we haven’t owned any of the most egregiously valued growth stocks, our portfolio has not been immune to this shifting tide, and several of our stocks declined severely in the latter months of 2021. Yet, we still had strong returns for the year.

Our portfolio construction is not foolproof, but it is designed in accordance with my view that value exists on a spectrum, from stocks that are undervalued on an asset basis (discount to book or NAV) to stocks that are undervalued on an underappreciated growth basis. It is no secret that over the last decade “growth” has greatly outperformed “value,” and once lauded value managers have struggled. It is entirely possible that over the next decade, the superstars of the past decade who were invested heavily in growth (and were well rewarded) will struggle.

It is my intention that on a portfolio level we will never be entirely beholden to any one valuation factor, and that we will remain diversified across this value spectrum. Over the last 6 years, our investments that have been more clearly traditional “value” have not performed as well as our investments that have more of a growth element to them, and it is entirely possible that over the next 6 years, our investments that have more of a growth element will struggle to keep up with our more traditional value investments.

What I don’t want to have is a portfolio of ~15 stocks that appears to be reasonably diversified, while in fact all 15 of those stocks are different takes on the same bet. What I do want is ~15 stocks that are diversified not only across industries and macro exposures, but also on market perception, probable event path, range of potential outcomes, and growth potential.

I do not intend to attempt to jump back and forth from what is currently not “working” to what is in favor, so quite naturally we will typically have a portion of our portfolio that is not working… until the pendulum inevitably swings.

More broadly, as has been the case in the past, I expect that going forward the bulk of the portfolio will be made up of companies that are essentially the orphaned stepchildren of traditional “growth” and “value” definitions.

You can read the entire letter here:

Laughing Water Capital Year-End Letter 2021

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