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TMFHelical (99.03)

The Power of the Pyramid

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November 09, 2010 – Comments (2) | RELATED TICKERS: GHDX , BRLI , KNDL

So, one thing to consider and relate is 'what kind of investor am I'.  It is a pretty common question.  The easy cop out answer would be -- a biotech (and by biotech, I mean healthcare) investor.  Cheesy answer, and I will forever struggle with the word biotech not having the same public connotation as how I define it.

No the two most common answers are value and growth.  If you want to add some differentiation, perhaps add in market cap preferences (large cap, small cap).  This is the so-called style boxed investment style answer. It's nice in that it makes for good pie charts to show differentiation and provides for a sense of diversification.

I'm Behavioral Investor.  Odds are, you are too.  I throw out the pie chart (and hit someone in the face with it, this is the Fool after all), and embrace the pyramid.

Behavioral Portfolio Theory was (so far as I know) initially proposed in 2000 by Meir Statman with Hersh Shrefrin.  The link is to a very academic paper (lots of math and references), but it is worth reading (skimming through the heavy math).  In a nutshell, investor behavior shows a tendency to build portfolios like layered pyramids, with a foundation of core stable holdings (downside protection or insurance), and a capstone of informed speculation (growth potential / lottery tickets).  Is this optimal?  It probably isn't but it is psychologically reassuring, and it is my opinion that investor psychology is a far bigger destroyer of returns than investor strategy.  So I embrace the framework.

Back to the Helical Portfolio.  I noted how I thought of each of the holdings I listed in my as core, mid-tier, or speculation.  The breakdown is as follows (amounts not updated from last post, and a couple of the holdings are doing quite well today, GHDX, KNDL):

Core Holdings……46.7%

Mid Tier………….27.9%

Speculation……….25.4%

That is a decent pyramid, and would probably be more so shaped if I did not call Bio-Reference Labs a speculation (gotta go with how you feel though, this is a psychology exercise after all).  I expect that this port will be more column shaped than pyramid moving forward, but this does reflect my current macro sentiment right now (so good).  Knowing this gives me a sense of confidence in the port as a whole and thus not acting reactionary to news about any one holding.

TMFHelical

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2 Comments – Post Your Own

#1) On November 09, 2010 at 5:03 PM, MegaEurope (22.68) wrote:

Cool idea.

So do you feel like there are actually 3 bumps in your personal utility curve corresponding to these 3 subportfolios?  Or do you feel like your utility curve is smoother and these classifications are somewhat arbitrary?

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#2) On November 10, 2010 at 9:26 AM, TMFHelical (99.03) wrote:

So here I am, retyping this the next day.  Apparently I didn't hit the final submit key.

MegaEurope

Glad you found the framework interesting.  I use this as a psycholoical gauge, and only check it peridoically (2x a year?).  It is a framework, but not a mathematical one for me.  I won't be mapping, or even thinking about, utility functions.  I also don't see them as subportfolios.  Each holding gets a mental rating, but it is the overall form that is of interest.  

Like anyone, I have a comfort level with investing that I struggle to define, even to myself.  Going through this exercise merely reasures me that what I am actually doing is consistent with how I feel about investing at the time.

When I first read the paper, I found it to be both philosophical and functional, but I lean toward the former.  It was a bit of an epiphany to see that how I invested and thought about investing did have a reasonable framework, just not a traditionally circulated one.

The classification of 'risk' on each holding is entirely arbitrary and based purely on sentiment.  It is how I feel, regardless of what I fundamentally think, about each holding. I would expect someone else to have completely different impressions on the same stocks.  I write it down, because ths changes with time, and I think it useful to occasionally explore why.  Cash for example (which I ignored in the exercise, but there isn't much) I sometimes consider a medium (mid-tier) risk due to opportunity considerations.  I don't feel that way now.

TMFHelical

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