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By Bridget B. Hughes, CFA | 06-02-2010 11:28 AM

Wadhwaney on Running a Concentrated Portfolio

Third Avenue International Value manager Amit Wadhwaney comments on how the firm's focus on downside protection and security selection affect performance.

Hughes: One of the other things you and I have talked about before is how in a 30- or 40-stock portfolio, at any given time a third of the portfolio is working, the rest of it is not working as well. Can you comment on the fund's performance in that regard?

Wadhwaney: Sure. There is a couple of things. I think, Bridget, you got it quite correct. I mean, if the portfolio is 100 to 150 stocks, which were much more broadly diversified across countries and geographies, the performance would much more mimic – potentially could mimic index performance. However, you reduce the number of stocks, you also – because of the kinds of stocks that you have, you have many countries where you have minimal to no representation. The by-product of that is the performance will vary enormously vis-à-vis any index that one chooses.

There is another aspect to our investment performance: security selection, which has an impact on investment performance specifically. The companies we buy tend to typically be extremely well capitalized. In the recent past or the last year and a half, one of the things you've seen is that companies that were almost at death's door, especially the financial companies, rebound and rebound massively.

Of course, to the extent you bought a safer company, which was not at risk of being terminal, you – obviously, while you certainly survive, you were guaranteed to survive the downside, you, of course, did not make quite as much money on the upside. There is an asymmetry to that risk of buying a highly leveraged, highly risky company with a view to goosing earnings. That's an asymmetry that we cannot take.

And finally, companies that we own can have company-specific events attached to them. This is a by-product of having a collection of companies, which are very asset-rich, sometimes become the targets of takeovers, or companies themselves can proactively split-up businesses, sell-off business, return capital to shareholders. These are inherently random events.

Now, if you have a concentrated portfolio of companies, which do things like that, your returns will necessarily, be quite lumpy. So they won't be smooth and necessarily tracking the index in a smooth manner, which is another way of saying, I suppose, you'll have periods of decent outperformance and also by symmetry underperformance.

Hughes: Which argues for a long-term investment horizon?

Wadhwaney: Absolutely, which is exactly what we advocate. We encourage our investors to think long term, focus on long term. The companies that you have here are companies that are going to be survivors through adversity, and hopefully, will thrive in good times.

Hughes: Well, thank you, Amit. I appreciate your time.

Wadhwaney: Bridget, thanks very much. Good speaking with you.

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