Circle of Competence

I’ve recently been searching for an answer to what I actually believe when it comes to managing money.  I previously and still do believe that with unsophisticated, risk averse individuals, or individuals in the “retirement red zone”, a simple, diversified ETF portfolio is still the most appropriate. 

However for individuals or institutions who are 1. Younger (> 10 years from retirement/whatever the goal for that pot of money is) 2. Risk seekers who prefer to take a chance 3. Client’s who truly believe in giving their advisor full discretion when it comes to managing their money (not constantly bugging them, asking why didn’t we sell here, why didn’t we buy here…etc) 4. Clients who believe that advisors who simply use asset allocation targeting via ETFs and Mutual Funds do not deserve their fee as they’re “not doing anything I couldn’t do” 5. Institutions with long term/perpetual money or the need to rapidly increase their funds to be able to fulfill an obligation or 6. Retirees who simply want to get maximum income through a growing dividend stream… I believe that a portfolio of 10-30 individual equities could be appropriate.

The issue most people have with owning individual equities is they believe that they are taking an unnecessary risk by not being as broadly diversified as they would be with funds.  However what most individuals fail to grasp is the fact that although diversification does reduce downside risk, it does so by also reducing upside potential, otherwise there would be an uneven risk-reward tradeoff that everyone would exploit (because it’s easy to get access to).  They are sometimes correct in their thinking that a portfolio of individual stocks can result in unnecessary unsystemic risk, however that’s because the majority of advisors who attempt to build those types of portfolios try to target broad diversification the way mutual funds. That’s where the problem lies. By attempting to select companies from every different industry they are bound to include some companies they do not fully understand.  No single individual is going to have a deep understanding on every sector, country, and firm’s risks and catalysts, so by targeting firms from every sector they are playing a dangerous game in the name of diversification.  Thus by pursuing that route of diversification, they are actually adding to the risk of the overall portfolio because they do not fully understand all of the risks associated with their stocks.  I call this risk “ignorance” risk.

I believe that a portfolio built by using stocks that operate in an individual’s “circle of competence”, while not necessarily providing the static definition of diversification, can actually provide superior protections without hindering the upside potential.  This is because if the stocks that are selected are selected from industries and firms that the individual truly understands, he is eliminating the possibility of utilizing something he does not understand, thus reducing the risk of being exposed to some tail risk that he never expected. The reason we do not see this very often is because it takes effort and time in order to create this circle of competence.  I currently am in the beginning phases of compiling my circle of competence and am beginning to realize how much of an undertaking it is.  The best way for me to keep my head around it is to write out my process below and use this giant post, that I hope no one ever reads, to keep my thoughts organized.

Circle of Competence – Categories:

Gaming – video game producers, platform makers

“Future” – 3d printing, TSLA and suppliers, emerging tech software/hardware

Internet – Social media, internet conglomerates (GOOG, AMZN, YHOO)

Alcohol – DEO, BUD, SAB, BEAM…

Casino – US plays based on increasing acceptance in gambling laws, Int’l (Macau exposure)

International Conglomerates – Provide a more stable exposures

Already considered in my “circle of competence” – Insurance companies, Autos

Now I know there’s no way I will get to know all of those industries deeply but I believe if I can get a handle on most of them, a portfolio made up of Video game, Internet, “Future Tech”, Alcohol, Insurance, and multi-nationals could provide similar downside protection that a fund can deliver via broader diversification, however I believe my portfolio will not reduce upside potential as much because it’s not overly diversified.

The only reason I’m actually posting this is because it will keep me accountable.  Even if no one ever reads this, as is my intention, the fact that I have written out my thoughts, and published it in a public forum will be much more likely to keep me accountable as this is something I really want to pursue.


Time is scary as fuck.  It places no weight on the items that we do.  It is not influenced by money, power, or sex.  It does not care if you are the leader of the free world or a homeless man shouting obscenities at people on the street.  It can not be controlled.  Time just is.  It continually hurdles us into an uncertain future without regard to any of our individual opinions.  When you’re at your lowest of lows time is your savior as it will propel you into a more promising future.  When you are at your highest highs it will pull you out of ecstasy and force you back into reality because the inevitable fact that it will cause your current ecstasy to end.

Time scares the shit out of me.  Time motivates me.

The Savior of the Rich

How did a radical, hippie, Jew who hated the self-righteous and despised the greed of the rich, become the icon of the western upper-class? Because no one cares.

More to come….

Thoughts on Money

I help people with money.  I help them preserve and/or grow their money.  Our industry is demonized by the public frequently, however I believe it is innately misunderstood.  So let me take you through my thoughts on why what we do is one of the most important professions around.

So why do we do what we do?  Simple – Money is the greatest form of good.  Money is purchasing power.  Purchasing power is the ability to fulfill a need for either one’s self or a need of others.  Therefore money is the most powerful tool on the planet.  Clothes only fulfill one need, food another, but money has that transitory property whereby it can fulfill any need.  Therefore the owner of money has the power to use the money as he sees fit, thereby providing him directly with the power of his paper.  So by helping people retain and grow their money, what we are actually doing is providing individuals with the power to meet any need that they may have, or any need that another will have.

Now that there is an understanding of what money is, and why it’s so passionately pursued, we can understand why wealth so often leads to power.  Wealth changes how a person is viewed.  Why does this happen?  We already answered that.  It’s because wealth means that an individual posses a great deal of money, and money is power.  Therefore that individual posses a great deal of power not just to meet any need he may have, but also to meet any need that another individual may have.  Therefore wealthy people are viewed at having a greater ability to meet the needs of an outsider than someone without wealth.  It’s why if a person with a $100,000 car pulls up to a restaurant they will get the best valet parking service, best table, and  the best service.  However an individual without wealth will receive nothing special.  This happens because the individuals providing the service know they will be compensated for their service, and the person with wealth has the power to meet more of their needs than the individual without wealth.

This seems to be common sense right?  I would think so, but if this is so why is it such a common trait of society to harbor resentment for those with more wealth than them?  One would think that they would fully expect an individual with more wealth to be treated better than himself.  The main reason is that money is misunderstood by both those that have it, and those who don’t.  Then stemming from that base of confusion there are two main reason that emerge as to why individuals tend to resent those with more money than themselves:

1. Because people are, by nature, competitive and wealth is an absolute.  Men can argue all day about who is stronger or faster, they may even compete in a race, but the fact that one of them won and one of them lost won’t settle anything.  The loser will simply bring up any excuse he can think of (poor surface, wasn’t feeling good today…etc) in order to avoid admittance that he is the inferior runner.  However money is an absolute.  If a man has more money than another man he simply can fulfill wants and needs that the other can not.  He has access to a level of service that the poorer man will not.  There is nothing the poorer man can argue with, because unlike athletics there is nothing to quarrel over.  It’s simple, the one has wealth and the other does not.  The one can have a Lamborghini, the other can not.  The one can access exclusive country clubs, and the other is not allowed in.  The richer man will live a different life than the poor man, and there is nothing the poor man can do besides toil away hoping to earn what the rich man has, which is the same as admitting defeat to the richer man.

2. People confuse money with greed.  When society belittles the rich they do not do it because the number in their bank account is larger than the general public’s, rather they demonize them because of the attitude that befalls those of wealth.  The wealthy tend to be pompous and greedy.  The always want more, and they expect to be treated differently, and that irritates society.

The third paragraph and #2 are a perpetual cycle.  Because of their wealth, wealthy individuals are treated differently by other members of society because the rest of society wants a share of their wealth.  However because they are constantly treated differently, the wealthy begin to expect it.  Then when they begin to act pompous, society turns on them although it was society who made them that way in the first place.

So us as wealth managers are an extension of the wealthy as they tend to be our clients.  Therefore society from time to time will degrade what we do because we are seen as being providers of this hateful item called money.  But money is misunderstood for the reason I laid out above.  And for those same reasons, money is the greatest good.  So what higher calling can there be than to help individuals grow their potential to fulfill their needs, and the needs of others?

Turkey (TUR) – A Different Type of Emerging Market

Turkey is different.  Most countries which are considered Emerging Markets today are new players on the world stage.  Turkey is not, in fact they held the stage for more than 6 centuries (America has only held it for 2).   In the 1900′s the Ottoman Empire fell apart.  After defeat in World War I the it was divided up, and Turkey was left with just the Anatolia Peninsula.  Then in 1923 Turkey split all ties from the Ottoman Empire and became simply The Republic of Turkey, and in 1952 Turkey joined NATO.  This was the turnaround point for Turkey.  They were seen as a bastion for the free world in an area of vastly expanding Soviet powers.  Back in those days (and today…) the US was willing to throw free money at any country who would carry out their beliefs in different areas of the world.  Since 1952 US investment in Turkey has done nothing but rise, and has once again made Turkey significant.

Turkey is different economically.  Most emerging markets are heavily reliant on commodities and energy for their growth.  For comparative purposes I’ll look at Peru (EPU) in comparison to Turkey (TUR) as they both have had similar rates of growth over the last few years.

Above are the holdings for EPU (top)  and TUR (bottom) .  EPU’s holdings look pretty standard for most emerging markets, overweight in the  materials sector.  However Turkey is really the only emerging market who is overweight in financials and consumer companies.  Materials are just 9% of the holdings.

So what?  Most of these material/commodity companies in emerging markets are strongly correlated with China.  Because of this link these companies, and countries, took off alongside China over the last decade.  However with the imminent slowing of China on the horizon, there is the risk of a major demand cutback.  China’s economy is becoming more reliant on consumer spending, and less so on construction and industrial output; therefore, their demand for material goods may decrease sharply over the next few years.  This is going to have an extremely negative impact on the emerging economies that rely on China’s consistent growth in order to grow themselves.

OK that makes sense but what does that have to do with Turkey?  In our world of low interest rates and low returns, most investors are counting on emerging markets for their growth opportunities.  However if what I outlined above comes to fruition, these growth opportunities may turn in to outright liabilities.  That’s where Turkey comes in.  Turkey is not linked with a sustained raw materials demand from China.  Turkey’s GDP has grown at over 8% (8.3% last year)  over the last 5 years, and has done so without relying on selling raw materials to a then growing China.  That is why Turkey is poised to flourish in a world where very few growth opportunities remain.  Turkey’s growth is more correlated with sustained consumption.  As shown above most of their holdings are banks and telecommunication companies.  This (to me) is a sign that they should not be lumped in with other emerging markets.

Is this growth sustainable?  As I outlined above, growth in many emerging market economies is not sustainable at current levels.  Once again, Turkey is different.  

The above data is from the World Bank.  The main point I’m trying to get across with the chart above relates to most investors main concern with Turkey: Turkey relies too much on Foreign Direct Investment.

Yes, FDI is huge for Turkey.  As I mentioned in the first paragraph, if it wasn’t for FDI Turkey would not be where it is today.  Some say that if FDI levels drop off, Turkey will drop with it.  That is clearly not the case.  FDI levels were very high in ’06 and ’07 when Turkey’s GDP was growing by 9%.  However its clear that  in ’09 and ’10 those levels dropped, but GDP growth did not drop with it.  Even with less than half of the Foreign Direct Investment levels seen in ’07, Turkey’s economy still expanded by 8.3%.  This is a sign that they have reached a point of relative stability, and will be able to sustain themselves to a certain extent even if FDI does begin to dry up.

Another positive sign for Turkey is a steadily declining unemployment rate.  Turkey’s unemployment was down to 8.9% in the most recent quarter.  That is a lower unemployment rate than the Euro area (10.8%)  and very close to the USA’s (8.2%).  As mentioned above, Turkey’s economy is driven by consumption, and to have disposable income most consumers need to be employed.  This low unemployment level supports the claim that the general population of Turkey is growing in wealth, which will lead to an increased capacity to consume/spend.  If unemployment remains low, and the middle class continues to get wealthier, the outlook for banks and consumer industries (57% of TUR’s holdings) looks very bright.

In conclusion Turkey is different.  TUR is a way to diversify emerging market exposure away from raw materials and dependence on China.  Turkey offers investors the ability to play the rising middle class in the years to come, while avoiding the slowdowns in most of the developed world.  Turkey is at a critical crossroad of the world geographically, and they may play a critical role financially in the years to come.

DisclosureI am long TUR.


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