In his 2001 Scion Value Fund Letter, Michael Burry explained how to build a portfolio that can withstand any shock. Here’s an excerpt from the letter:
A portfolio manager must understand that safeguarding against loss does not end with finding the perfect security at the perfect price. If it did, then the perfect portfolio would likely consist of one security. Rather, to the extent possible, I have the responsibility to structure the portfolio such that if any of a number of unforeseen events occur, that I do not lose the whole, or even a significant portion, of the clients’ money. To do this, I seek to minimize the correlation between the intrinsic values of the various securities held in the portfolio.
Minimizing this correlation involves a bit of diversification among industries. Minimizing this correlation does not involve straying from sound principles of securities analysis. Including speculative or overpriced stocks in the portfolio simply to diversify against the impact of an array of possible external shocks is simply irrational given the relative odds involved. Moreover, minimizing this correlation does not require a portfolio of more than fifteen or so stocks.
Therefore, a relatively concentrated portfolio may still offer decent protection against unforeseen adverse future circumstance.
Although it so happened that on September 11th the Fund’s largest position was an airline, and that another large position was a hotel stock, the impact of this tragedy should not, in the long-term, prove significant to the Fund’s performance. The principles by which I invest served the Fund well during the recent turbulent time, and I expect that these principles, applied consistently, will continue to serve the Fund well — whatever additional shocks the future may hold.
You can read the entire letter here:
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