Hedge Funds - Hedge Your Bets

It works great when everything is going up.  But alas, everything doesn't always go up...

Early this year one of his investments went bad.  Management couldn’t deliver the sales that they had been promising.  The customers liked the product but were delaying orders for one reason or another.  The company started bleeding money and was on the verge of bankruptcy. The stock price plummeted.

I don’t care who you are or how much money you have - situations like these are very painful and gut wrenching.

With his concentrated portfolio, Robert’s loss was devastating.

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Significant losses like these are extremely difficult to recover from.  In Robert’s case, a fundamental loss of a single investment destroyed as much as 16% of his total investment portfolio.  This is why we advocate a diversified portfolio investment strategy (regardless of what you're investing in).

Now there is a risk of being too diversified.  Owning too many stocks, options, or commodities can be a bad thing as well.  For example, if you own 1000 different stocks the returns on any single investment are so diminished you eliminate any chance for outsized gains on your portfolio.  If you have a stock that doubles in price the resulting profit in your portfolio is limited to 1/10th of a percent.

Every person needs to look at their own investment profile and risk strategy to determine how diversified they should be.  Typically, this can range from 25 to 50 holdings or more.  In The Options Forecast for example, we encourage investors not to put more than 4-5% of their total options trading capital into any single investment.

As our call ended, Robert mentioned that he had more than doubled the number of stocks in his portfolio.  If he would have done it sooner, he may have saved himself and his outside investors millions.

•  BSMH Capital Upgraded VeraSun (VSE) this week despite ethanol prices touching new lows, and corn prices hovering near long term highs.

•  After announcing horrible quarterly results, Smith & Wesson (SWHC) was downgraded by three firms, Cowen & Co, DA Davidson, and Rodman & Renshaw.

•  Bear Stearns initiated coverage on ConAgra (CAG) with an outperform rating.

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