- January 20, 2025
- Posted by: CFA Society India
- Category:ExPress

Written By
Jinesh Sarat Sheth, CFA, CA
Investment Director
Jezoor (Family Office)
Knowing what to buy is important; but wait; knowing how much to buy is even more important!! Portfolio return does not just depend on which stocks you have bought but also on how much weight have you allocated towards its constituents.
“Owning stocks is like having children – don’t get involved with more than you can handle” – Peter Lynch
Be it Global investment legends Warren Buffett, Charlie Munger, Phil Fisher, Peter Lynch or our own Indian Investment Gurus Rakesh Jhunjhunwala & Radhakrishna Damani all have been advocating taking concentrated bets if not through words but at least through deeds.
“Very few people have gotten rich on their seventh best idea. But a lot of people have gotten rich with their best idea.” —Warren Buffett
At its peak (before the Q2CY’24 exit), more than 50% of Berkshire’s entire portfolio was invested only in Apple. Even as on 30th Sep 2024, top 5 holdings of Berkshire (Apple, American Express, BoA, Coke & Chevron) constitutes a massive 72% of its portfolio.
“A lot of people think that if they have a hundred stocks they’re investing more professionally than they are if they have four or five. I regard this as insanity.” –Charlie Munger
If we must talk about concentration; Late Charlie Munger, was the king of concentration; his portfolio under Daily Journal Corp had only 4 stocks and out of which Wells Fargo & BoA constituted 89% of the portfolio.
As per Phil Fisher’s book, “Common Stocks and Uncommon Profits”; often 75% of his portfolio was concentrated in 3 stocks.
Howard Marks current portfolio under Oaktree (Sep 2024) has 52% exposure in top 5 stocks.
From Indian perspective, we know Radhakrishna Damani had historically taken concentrated positions; presently he has 95%+ of his net worth from only one stock which is D’mart.
Late Rakesh Jhunjhunwala’s portfolio has more than 60% in top 5 stocks (Titan, Concord Bio, Star Health, Tata Motors, & Metro) as of Sep 2024. During a Conference in 2023, I had an enlightening interaction with Utpal Seth, CEO and Senior Partner of Rare Enterprises (RJs firm), while explaining the concept of Terminal Value Investing, he shared that how Rakesh ji always used to develop differentiated insights about a stock which led to forming of strong conviction and, consequently giving him the courage to invest heavily. He offered a profound insight, that risk does not stem from the weight of stock but from the lack of knowledge about its business. It takes lot of hard work, experience that leads to apt judgement (or gut feel), skillset & mindset to develop the differentiated insight.
Within Kuwait or GCC, we know almost all the successful 1st generation business families have become wealthy taking concentrated exposure be it into real estate, retail, commodities, auto, banking & financial services & other sectors. The same applies for most of the successful 1st generation global business families. It is because actively operating businesses gives you differentiated insight. If that’s the case with businessmen or women why not the same could become possible for investors (specially, the ones who can influence the board decisions of their investee companies). But for a small individual investor like us it is not easy to get a differentiated insight.
For the past three decades, Motilal Oswal has published an Annual Wealth Creation Study, with each study featuring a unique and insightful theme. I make it a habit not only to read the latest document as soon as it is released but also to write my interpretations and share and discuss them with my principals. Additionally, I occasionally revisit the older studies. One of these studies had the theme of ‘Focused Investing’ which is quite interesting and something I will discuss at a later stage in this article.
Let’s explore the real life story of three scientists John Larry Kelly Jr, Noble laureate Claude Shannon (known as “father of information theory“) and mathematician, researcher and a successful hedge fund manager Ed Thorp. Kelly Jr, a renowned scientist; was an associate of Shannon, had developed a model that can determine the optimal wager amount to maximize the winnings in gambling. The story goes that Shannon, and his wife went to Las Vegas with Ed Thorp (who developed blackjack game theory based on Kelly theory and later as hedge fund manager gave 20%+ returns over almost 3 decades) where they used the theory to win big in Blackjack and Roulette and later the theory became famous as Kelly Criterion. This theory was later used by Quant investment legend Late Jim Simons (whose fund generated return @62% CAGR for 3 decades). Even Warren buffet used the theory conceptually for determining the size of his allocation. Kelly Criterion is ideally suited for gambling, but a conceptual analysis can assist in position sizing (meaning determining allocation) for equities as well.
Let’s simply the complex mathematical theorem and try to replicate the same to determine investment allocation:
k = (bp – q) / b
where: k is the Kelly percentage; the fraction of the current bet size on total wager,
b is the net odds (expressed as $ to be won for every $ bet) or win-loss ratio,
p is the winning probability, and
q is the losing probability.
Using a simple example to explain the theory:
You are offered a $100 bet that every time a coin is tossed, and you call heads or tails correctly, you will win $200. You have set aside $1,000 for a series of bets. What should be your betting strategy?
Here, b (odds) = 200 ÷ 100 = 2. Given a fair coin, the chances of correctly calling heads or tails are 50%. p (probability of win) = 50%
q (probability of loss) = 50%.
Therefore k = (2 x 0.5 – 0.5) ÷ 2 = 25%
Thus, you will bet 25% of $1,000, i.e. $250 in your first bet. The subsequent bet size is dependent on the outcome of your first bet.
This is the simple example to understand the theoretical concept; while in practice its quite complex as you need to run trials and simulations & the probability of occurrence of an outcome may be dependent or independent of prior outcomes. Here we are applying a simplified version of the criterion for stocks.
Motilal Oswal in its research about “Focused Investing” modifies this Kelly Criterion to rationalize the stock allocation:
k = (Up – Dq) / U k = (Edge/Odds)
where: k is the fraction of the allocation to invest in a particular stock,
U is the possible upside in the stock,
p is the probability of such upside,
D is the possible downside, and
q is the probability of such downside.
Let’s take an example of a recently listed stock Tech stock A (which has been underperforming markets & its peers since listing). Its market price at the time of authoring this article is INR 815. As per my valuation estimates & probability expectations the upside potential is 100% and probability of such upside is 50% and downside potential is 40% and probability of such downside is 30%. I am assuming a timeline of 3 years. Let’s take a relatively larger Information Technology stock B, which has been an underperformer amongst its peers over the last 5 years. The market price is close to INR 1,700. As per my valuation estimates & probability expectations, the likelihood of a 100% upside potential is 20% and the likelihood of 30% downside is 35%.
k(A) = (1×0.5-0.4×0.3)/ 1 = 0.38
k(B) = (1×0.2-0.3×0.35)/ 1= 0.095
k(A) = 0.38 > k(B) = 0.095; implying the following:
Tech Stock A – I should invest sizably; as per the score, 38% of my investment should be allocated.
IT Stock B – I can invest, but not sizably.
In practice, there are rarely only two stocks to choose from. Therefore, I must apply this approach with all the potential stocks that I want to buy and weigh them according to the k-score. I can then utilize a fractional Kelly (if not full Kelly) as half or one third or one fourth of what the score suggests. A higher score indicates a stronger belief in my understanding of the stock’s business potential and a higher level of conviction.
If your k turns out to zero or negative for any stock – Avoid taking any position in such stocks.
To conclude in simple terms; Kelly criterion recommend allocating big whenever you have satisfied both the below provided criteria:
- you have identified stocks based on (thorough fundamental analysis) with asymmetric payoff and
- you have an edge (based on information or analysis) versus consensus
Referring to Motilal Oswal research, it proposes a concept of focused investing which according to them is a golden mean between Diversified and Concentrated Investing. Diversification is an insurance against ignorance, whereas concentrated positions may bring in high volatility to the portfolio. The research suggests a middle path in the form of Focused Investing (which avoids excessive diversification and excessive concentration simultaneously); such a strategy provides the optimal balance between both philosophies, offering sufficient risk diversification while still enhancing potential returns.
4 keys to successful Focused Investing are:
- Well defined portfolio goal (like drafting an Investor Policy Statement – IPS),
- Superior stock selection (using your investment philosophy),
- Rational allocation (based on Kelly’s or fractional Kelly’s or Confidence-Adjusted Payoff by Motilal Oswal or other models used by other successful investors or your own model which is suitable to your requirements) and
- Performance evaluation, active monitoring and improvement
My 2 cents
Portfolio allocation combines the precision of mathematics with the creativity of art. While mathematical analysis is essential, I believe that temperament, emotions, and intuition are equally crucial in the allocation process. In my perspective, every investor has unique financial and personal circumstances, distinct behavioural tendencies, varied psychological profiles, and differing levels of expertise in navigating the capital markets. Therefore, no individual should replicate someone else’s asset allocation without first understanding their own and other’s risk appetite, return expectations, and unique circumstances. While many great investors have been believer in taking concentrated positions, almost all of them have consistently emphasized that this strategy is suitable only for those investors who deeply understands market dynamics, risks factors, and possesses a differentiated insight. We must remember that Warren Buffett and late Charlie Munger achieved an unparalleled track record of successful investing over more than seven decades—a feat that remains unmatched. Both have been unique investors, each with their own differentiated insights. Given the dynamic nature of investing, I do not advocate adhering rigidly to any specific criteria; instead, treat them as tools while relying on your own judgment, which develops and sharpens over time with experience.
Sir John Templeton, the contrarian legend celebrated as the greatest global stock picker of the 20th century, wrote in a letter advocating for diversification after his illustrious career – “In my 45-year career as an investment counsellor, humility did show me the need for worldwide diversification to reduce risk. That career did help me to become more and more humble because statistics showed that when I advised a client to buy one stock to replace another, about one-third of the time the client would have done better to ignore my advice. The only investors who shouldn’t diversify are those who are right 100 percent of the time.”
For all the enthusiasts who wants to embark on capital markets, I recommend starting your journey with the following simple steps:
Step 1 – Develop an asset allocation policy tailored to your family’s unique circumstances, considering your return requirements, tax status, liquidity needs to meet present liabilities, expected future obligations & potential contingencies. Additionally, consider realistic aspirations for yourself and family and assess the risk tolerance levels & then align it with your willingness to take risk. For equity allocation, the policy drafted should outline whether to pursue passive investing through indexing (buying ETF of major indices, which is by the way a great strategy for non-technical or non-active investors) or active investing.
Step 2 – Begin with a well-diversified portfolio aligned with your allocation policy. Gradually, you will gain clarity on the levels of focus or concentration that best suits your risk return trade off, along with other consequential factors and development of differentiated insight. Exercise your judgement.
Step 3 (most important) – Ultimately, the key is to enjoy the process of becoming a better investor with each passing station of your investing journey; I believe that’s what truly matters.
My caveat: Concentrated investing is not suitable for managers overseeing external funds (institutional/family office/retail clients), where the fund manager must strictly adhere to the investment mandate. Concentrated or focused investing is particularly suited for managing own wealth.
Ending with Late Shri Rakesh Jhunjhunwala’s quote – “I only make mistakes, which I can afford, where I can lift to begin again”
Disclaimer by the Author: I have used some stocks as case studies as an example for our study purposes, these are not to be construed as any recommendation. It is safe to assume that I & and my firm may have positions in the stocks discussed in this article. This analysis is just for study purpose, me and my firm are not liable for any actions taken by readers based on this study.
Invest wisely to be stress-free!!
Source: Berkshire Hathaway, Motilal Oswal, Quantdare, Exitvelocity.substack, Gurufocus, Hedge follow, AlbionResearch, Moneycontrol, CNBC, Trendlyne, Bloomberg, Corporate Finance Institute, Sirjohntempleton.org, Forbes, Firstlinks, Valuesider, Medallion Fund
Disclaimer: “Any views or opinions represented in this blog are personal and belong solely to the author and do not represent views of CFA Society India or those of people, institutions or organizations that the owner may or may not be associated with in professional or personal capacity, unless explicitly stated.”