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Monday, August 15, 2011

My Thoughts on Diversification

A key aspect of my investment strategy is about uncovering fundamental value in the small and micro cap sector of the Australian market. Naturally this involves a great deal of research and analysis across a number of companies and sectors. The traditional approach to investing is to create a diversified portfolio of stocks. Many financial advisors and analysts regularly state that your portfolio should hold between 10 and 25 individual companies.

My approach is different and is based on the following: If I have spent hours of research trying to uncover the best possible investment why would I then also consider investing in those stocks that were on the next rung down in terms of potential and risk. Now this is not to say that I will only invest in one stock in each sector, but highlights that if you are confident in your research and analysis why would you then second guess yourself by placing some of those funds into another company that perhaps did not fit all of your investment criteria.

Ideally I see my portfolio comprising between four and six stocks with a portion held in cash (in case a new opportunity presents itself). By limiting my portfolio to no more than six stocks I will know each one better, perform more detailed analysis and keep up to date with any fundamental changes in value that many alter my decision to buy, hold or sell. These will also be the stocks that I am most confident about and therefore hold the best potential to deliver a return in my opinion.

As I mentioned above this does not necessary limit me to only one stock in a certain sector and is more based on the current status and potential of each individual opportunity. For example if I decide to invest in a gold producer I will attempt to identify the one that offers the best potential, but I could also decide to invest in a gold explorer or a company that is in the process of developing a gold mine (all gold stocks, but all at different stages of their life). By the same token I could invest in the best gold mine I can find in Australia, but also the best one I identify in Asia. This will allow me to diversify within sectors as well as across sectors.

As you will see from my current holdings in OBJ and MHM I am currently exposed to the bio-tech and resource/materials sector and I do see the majority of my funds being placed in these sectors. I am currently in the process of evaluating a number of gold stocks, but am yet to make a purchase given the current market turmoil. I am also anticipating a slight pull back in gold and/or a rally in the AUD that may provide a better short term entry into any gold stock.

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