The cost of confidence in investments

We often talk about the importance of a fund manager having high conviction in their investments, says Cris Sholto Heaton. But sometimes too much conviction can go badly wrong.

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We often talk about the importance of a fund manager having high conviction in their investments but sometimes too much conviction can go badly wrong. Take the example of one Bangkok-based hedge fund from which I've been receiving updates for many years, ever since I expressed interest in its spectacular track record. The fund had returned an average of about 18% per year for more than 25 years, by applying a value investing approach in the Thai market.

It was notable as a lot of specialist funds are for holding a very concentrated portfolio (often not much more than ten stocks) and for being willing to hold a very large proportion of the portfolio in its top picks. There had been some big short-term losses along the way in line with the wider market Thailand is extremely volatile and prone to crises but nothing that looked like a permanent setback.

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Last year, the fund did even better than usual, returning more than 50% (the index managed about 25%). This year has been rather less kind: it's down more than 35%, compared with a rise of 11% in the Thai market. Both last year's boom and this year's bust are down to the same stock and the same investment principle and carry a lesson for all of us.

The fund had invested in a fast-growing company that provided loans for people in several southeast Asian countries to buy motorbikes. This stock had become a favourite with investors and its shares soared in 2016. It had also grown to be an enormous part of this fund's portfolio (it must have been in the region of 50% of assets at its peak). Then in March the firm's accountants raised some concerns about its financials and the shares collapsed (the chief executive has since been charged by the Thai regulator).

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The tale of an obscure stock and an obscure fund is relevant to any investor, since it shows the importance of having the right level of diversification. No matter how confident you are in an investment, it's a mistake to allow it to dominate your portfolio to the point where problems with it could do catastrophic damage.

In this case, an extremely experienced fund manager with plenty of ability to do in-depth research on his holding was still blindsided by problems that he clearly didn't foresee. Most private investors are in a far less favourable position and could get into trouble much more easily.

It's a mistake to diversify too much: each of us has only a limited number of good ideas and if we spread ourselves too thinly we will invest in lesser ones, leading to "diworsification" rather than diversification. But following sensible principles such as those in the box below can do much to save us from disaster.

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