JP Morgans rather dramatically titled EYE ON THE MARKET Special Edition is an interesting read but probably not for the reasons they had hoped. Essentially the piece is an advertisement for diversification within a portfolio and is one of those wonderful documents that analysts get paid to produce. From a philosophical standpoint I agree with the need for diversification but I regard it as a much more complex topic than simply buying shares with different names, there is also the accessory issue that the more stocks within a given index you buy the more your performance begins to replicate the index. For example I could never understand why people would buy a handful of the S&P ASX 20 component stocks and not simply buy the S&P ASX 20 ETF (ILC) I understand why people end up with a portfolio that replicates an index and hence an ETF – its better for the broker to get you to part with multiple lots of brokerage rather than just one.
My reading of this report actually gives hints to something else which in my mind is much more important that the notion of simple diversification and to highlight the points I took from the report I have ripped out a few charts for comment.
1. Buy and Hold remains the stupidest idea in investment.
These two graphics display quite nicely the notion that buy and hold is a folly because of the number of companies that simply fail. It does also highlight the notion of survivor bias which is something people do bang on about as if it totally invalidates any form of testing when in fact it is easy to compensate for.
2. No stops no play.
I am always intrigued at the number of so called professionals who have no plan whatsoever for engaging the market. The cornerstone of my plan is to run away from any trade that has gone bad at the first opportunity.
3. Within any population there are going to extreme winners.
4. Trends exit within any market and they persist for years.