Joel Greenblatt: How To Think About Concentration In Portfolios

In his latest interview on the Richer, Wiser, Happier Podcast, Joel Greenblatt explains how to think about concentration in portfolios. Here’s an excerpt from the interview:

I don’t consider six to eight names of making up 80% of your portfolio, particularly concentrated. One name for your whole portfolio, that’s pretty concentrated.

Once again, I pull out and I’m just going to be spit balling that I’m close here is that, when Warren Buffet said, let’s say you sell your business and you get a million dollars. Then you look around town at a couple hundred businesses and picking six or eight that you can buy at a good price that are in good businesses, with management that you think is going to do a good job, and you did your homework.

Then you divided that million dollars into six or eight businesses that you thought were the best and best price with good futures in town, and well managed. No one would say you’re crazy because you’re thinking of them as businesses. You divided your investment in its businesses.

If you think of them as stocks and pieces of paper that bounce around that you’re going to get quotes on every day, and there’s going to be some volatility involved, as opposed to taking a three or five year horizon in owning those six or eight different businesses. As a businessman, no one would think you are crazy, they’d think you’re pretty prudent. You took that million dollar windfall from your business and divided it in six or eight places, they’d say,

“Hey, you’re a conservative guy.” But put a stock price on it every day, people change the analysis. If you read finance literature, it’s myopic loss aversion, in other words, people don’t like losing, at least getting a quote, 30 to 40% down. Very big institutions invest in private equity, and those are funds that invest in a small handful of businesses and they leverage them up, and no one thinks they’re crazy.

What they do is, they just don’t mark down their portfolios the way the stock market does. They wait a few months, see what’s going on and pick a number that everyone’s in on it. The person who bought it doesn’t want to get their portfolio marked down, and the person who’s a manager doesn’t want to mark down their portfolio, so I think it smooths the ride.

Even though they’re buying leverage equity stubs in a very concentrated portfolio, and everyone thinks those guys are basically geniuses and they make a lot of money, so I don’t see it any different. I just get a quote every day and I got to contextualize that in the right way.

You can listen to the entire interview here: