Stick to Your Specialty

 | Dec 22, 2011 | 9:30 AM EST
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Last week, Tim Collins wrote a thoughtful article for Real Money and Real Money Pro readers called, "Eggs, Baskets and Risk." In that article, Collins thinks about risk and the wisdom of "putting all your eggs in one basket." The article was effective; he got me thinking about going over to the dark side.

Most investors understand that building a balanced portfolio is a prudent way to create wealth. If you ever watch Jim Cramer's "Mad Money," you will understand that a balanced portfolio can manage risk and build wealth at the same time.

But Collins' article raises an interesting question. He wonders about the wisdom of putting all your eggs in one basket:

On the surface, it is a risky proposition that risks more than it rewards. You should never do it ... right? After all, it breaks a cardinal rule: Slow and steady wins the race. With a nice diversified portfolio, you'll be able to enjoy the fruits of your steadfast, careful approach in your golden years. But when I look around at most of the very successful folks that I know, they didn't take that path. The person who quit her job to risk everything and start her own business, the professional athlete who left school early and focused only on his sport, the trader/manager who took one very large position in a specific thesis, sector or even company -- these are some of the folks who find such great success so quickly that work becomes optional going forward. Perhaps they can focus on doing what they truly love, if they are not doing it already....

A risk-averse or diversified approach is often the best approach for most, but for some -- a small few -- consider pushing aside the clichés and making a decision based on knowing yourself and your own situation.

As someone who created a number of electric power and natural gas portfolios, I find Collins' warning makes a lot of sense. The rule of a utility trading floor is never speculate and always (yes, always) hedge every open position.

Portfolios both saved our company's book and prevented us from making a killing. I always felt relieved and chagrinned at the same time. But that was the commodities business, and Collins was discussing equities.

When I think about equities, I think about my good friend who tried to maintain a diversified portfolio only to become frustrated with too much information. He was a highly intelligent man, with three separate graduate degrees in business, international relations and engineering. Even with his background, however, massive amounts of information overwhelmed him. After years to trying to manage balanced portfolios, he decided to specialize. Only then did he make some money.

My friends' experiences are consistent with my experience. It seems generalists struggle and specialists win. I've learned most professional investors learned to specialize and stay within a comfortable silo.

Harvard Business School professor Michael Porter makes the case for specialization and leadership. Anyone who has studied strategy and used Porter's book, Competitive Advantage, understands that successful companies must become cost leaders or they will become bloodied. Companies cannot achieve cost leadership if they are followers and generalists soon fade into oblivion.

General Electric (GE), Siemens (SI), ABB (ABB), 3M Company (MMM), Berkshire Hathaway (BRK.A, BRK.B) and many other Fortune 1000 companies follow Porter's model. While these companies may park leadership in subsidiaries, they don't hang on to lagging investments for long.

Investors comfortable with a prudent amounts of risk should learn from Porter and these great companies. Focused investors have to be willing to specialize, do the deep dive, understand their segment and strategically invest. They should also consider going short when times dictate and go long when their segment turns.

Not everyone can short or sell all out. Stephanie Link points out that Jim Cramer's charitable trust (Action Alerts PLUS) and mutual funds can do neither. In these cases, fund managers must resort to portfolio balancing and hedging to weather whatever the market hands them.

As Collins argues, "A risk-averse or diversified approach is often the best approach for most, but for some -- a small few -- consider pushing aside the clichés and making a decision based on knowing yourself and your own situation." I would add, know your market segment.

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