Why portfolio managers must avoid risk dilution

Investment firm CEO says a good idea should not be held back by over diversification

Why portfolio managers must avoid risk dilution

Had a great investment idea but failed to capitalize? Money managers have been warned about the risk of return dilution.

Talbot Babineau, president and CEO at IBV Capital, was discussing the second quarter performance of his firm’s IBV Capital Global Value Fund, which increased by 11.6% in the second quarter of 2018.

Babineau highlighted one of the fund’s holdings as a great example of not leaning too heavily on diversification for diversification’s sake.

He said the investment in Ascendant Group was, upon analysis, so compelling that to limit the size of the position would have harmed the fund. It’s an approach that ties into what Babineau calls the virtues of assembling a portfolio of securities with embedded catalysts.

He said: “Our rationale for this approach is that embedded catalysts eventually come to fruition and unlock shareholder value. Therefore, a portfolio of securities sharing this characteristic would create idiosyncratic returns – an attractive feature to us in the current investment environment.”

He added that Ascendant Group had moved last quarter to unlock shareholder value; something IBV Capital had predicted would take a while to unfold but that, now done, increases its attractiveness as an investment.

He said: “While the sizing of our position was subject to extensive internal debate, we concluded that the asymmetrical return-to-risk profile was so great that allocating only a small portion of capital to it would have proven a lost opportunity – particularly given our deep research and understanding of the investment.

“The notion that a great investment idea would have only a modest impact on returns is a concept we refer to internally as risk of return dilution. We strongly believe that diluting returns with diversification, merely for diversification’s sake, is a risk that carries an actual cost. Of course, the cost is intangible and therefore doesn’t appear in actual returns. However, as far as we’re concerned, it is there, and we try our absolute best to avoid it.

“Throughout the quarter, we added one new investment and sold our investment in Tesco PLC, maintaining the number of positions within our portfolio at 15. While these activities impacted our portfolio’s intrinsic and market value, in absolute terms they were overwhelmed by the dramatic share price increase of Ascendant Group.”


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