Li Lu on Diversification as a Concentrated Investor | FAME 2012 【C:L.L Ep.42】

[Transcript]

AUDIENCE MEMBER: Thank you for coming today. I want to ask you a question about portfolio construction and just hear your comments on diversification. In the last session, there was a lot of discussion about diversification and the importance of it. My sense is that you're more of a concentrated investor, some other investors aren't like that. Where does that – what kind of role does diversification play? Or how do you think of it in building a portfolio?

LI LU: Well, you always have to have some kind of diversification because;

A. You could be wrong.

B. Even if you're right, you're betting on statistics.

In other words, the future is essentially a distribution of all probabilities, let's say you have a 90% of conviction you're right and that event is 90%, but then 10% chance happened and so you don't want to that 10% to get you out of the game. So you do need to diversification.

On the other hand, that recognizing is extremely rare to find no-brainer great opportunities, extremely rare. In fact, you have to wait for a long time before the fat pitch to come to you. So when that happens, you certainly do not want to diversify away the opportunity that you have been waiting patiently for a long time to discover for some really inferior other opportunities.

See investment is essentially is an opportunity cost. So one other alternative have to really justify itself by comparing with what you already have. And so when you make that comparison, you tend not to really diversify too much. You would have find a few very very good ones that have a very high conviction that might arise. And so yes, you do a little of both.

AUDIENCE MEMBER: So in that example – you're kind of hitting precisely what I'm getting at – In a very high conviction idea, what do you feel the limits are in terms of, you know, how much you could be invested?

LI LU: Well, I want to say as I said that all decisions ought to be looked through the concept of opportunity cost is what else can I do with the cash I have? And cash by the way is really a fundamentally important asset. If I don't really find anything else or if I find a bunch of other opportunities inferior to cash that I would have keep in cash.

And so, I would say that it never bothers me at all with a large amount of cash and I can't find a great opportunities. At the same time when I find, say, one good ideas, I'll let it get a little of a bigger percentage of the portfolio. And then everything else would compare with what I already have which is cash.

And sometimes holding cash can be the result of a bottom-up research. I've always believed that's the case.

(Source: https://youtu.be/P4jZFgWNY2E)

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