Risk Management in Concentrated Portfolios

Concentrated portfolios can generate exceptional returns, but they require rigorous risk management. The difference between a concentrated portfolio that generates 20% returns and one that suffers a 50% drawdown often comes down to risk management discipline.

The Concentration Paradox

Concentration amplifies both gains and losses. A portfolio with 20 positions has less volatility than a portfolio with 5 positions. But the concentrated portfolio, if constructed properly, can generate superior returns because you're deploying capital in your highest-conviction ideas.

The key is managing the risks inherent in concentration. This requires position sizing discipline, correlation analysis, and stress testing.

Position Sizing Framework

Effective position sizing ensures that no single position can destroy your portfolio. A common framework: your largest position should not exceed 10% of portfolio value, and your top 5 positions should not exceed 40% combined.

But position sizing should also account for volatility and correlation. A highly volatile, uncorrelated position might warrant a smaller allocation than a stable, correlated position.

Correlation Analysis

Concentrated portfolios require careful attention to correlation. If your five largest positions are all technology stocks, you don't have a concentrated portfolio—you have a concentrated bet on technology. True concentration requires diversification across uncorrelated assets.

We analyze correlations across market cycles, not just recent periods. Assets that appear uncorrelated during calm markets often become highly correlated during stress periods. This is why we stress-test portfolios against historical worst-case scenarios.

Stress Testing and Scenario Analysis

Before implementing a concentrated portfolio, stress-test it against historical scenarios: 2008 financial crisis, 2020 pandemic, 2000-2002 tech crash. How does your portfolio perform in each scenario? If any single scenario results in a drawdown exceeding your risk tolerance, adjust your positioning.

Rigorous risk management allows concentrated portfolios to generate exceptional returns while protecting capital during market stress. This is the foundation of our investment approach at Kairross.