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WHY WE DON’T LIKE PIE
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Diversification has become industry convention for reducing risk largely due to uncertainty in this business. Let’s
face it, if you had 100% certainty in an investment, you’d make that one investment and rest easy. The more
uncertain you are, the more you feel the need to diversify your investments because if a couple of the businesses
in your portfolio do poorly, the performance of the others will hopefully offset it. This is where mutual funds
come in. They allow investors to buy a stake in a collection of businesses.
Investments are like a box of crayons?
Industry regulators recommend that a fund company’s holdings should be “clearly organized” and “presented in a
way that’s both meaningful and understandable to readers.” We completely agree. Providing information to
investors that’s easy to understand is important – better informed investors typically make better investment
decisions. Trouble is, it’s commonplace to organize holdings by geography and/or sector. We’ve always felt that
classifying portfolio holdings in either of these ways is misleading to you and here’s why.
This information is supposed to show how well-diversified a portfolio is. More slices of pie means the investment
isn’t too exposed to any one sector or region. We can see how this makes sense to some investors. After all, we
know we’re not supposed to put all our filling into one pie shell (that’s a saying, right?)
Below are conventional pie charts that show EdgePoint Global’s holdings segmented first by sector and then by
geography. Sure, all those colours make them visually pleasing but how does this information help investors make
informed decisions about their investments? We’d suggest it doesn’t help them much at all.
EPGP Sector Distribution
As at November 30, 2016.
According to the chart, the biggest slice of pie is the Industrials sector. Are we under-diversified because we have
too much exposure to industrials? Some might say so. Dig deeper and you’ll see EdgePoint Global’s holdings are
actually very diverse despite being in the same category.
WESCO International Inc.: distributes electrical products
WABCO Holdings Inc.: global supplier for commercial vehicles
Union Pacific Corp.: operates railroads in the United States
Generac Holdings Inc.: manufactures backup power generation equipment
Flowserve Corp.: a supplier of industrial flow management equipment
Rexnord Corp.: a supplier of power transmission components and water management & control systems
AENA, S.A.: owns and operates airports in Spain
Wabtec Corp.: a provider of equipment and services for the global rail industry
Kubota Corp.: agriculture and farm machinery
Team Inc.: provides specialized maintenance services for piping systems
Grafton Group plc: operates building and plumbing supply outlets in the U.K. and Ireland
Think about it, what does the owner/operator of airports in Spain have in common with a plumbing supply
company in Ireland other than they both have to deal with a lot of…well you know. How about a manufacturer of
farm machinery and a railroad operator? The only similarity we see here is they’re both things the average threeyear old is obsessed with. In case you don’t get the picture yet, here’s one more: an electrical product distributor
and a global supplier of commercial vehicles. Both company names start with w? That’s where the similarities end
as far as we can tell.
We think it’s silly to classify all these diverse businesses together in one sector because each represents a unique
idea or proprietary insight. We don’t have some grand idea of why we think industrials are the place to invest;
rather our Investment team has a distinct idea on how each of these businesses can grow over the long term. The
same can be said for the other businesses in the portfolio. We like these 11 businesses for a variety of reasons,
none of which are they’re all classified as industrials.
Location, location
On to another arbitrary classification – geography. For arguments sake, let’s review EdgePoint Global’s
breakdown. Notice that almost three quarters of the pie is allocated to the United States. Seems crazy, right?
Obviously we’re over-exposed to the United States which means our Global Portfolio isn’t well-protected against
the potential risks that would come with a downturn in the U.S. economy. We really hate the geographic
approach though because we’ve yet to figure out how a company’s head-office location has anything to do with
its revenue sources.
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EPGP Country Distribution
November 30, 2016.
This is a list of the companies in our Global Portfolio that happen to have head offices in the United States and
the percentage of their revenue that come from outside of it.
% of revenue from
outside the U.S.
25%
27%
0%
24%
66%
10%
15%
2%
30%
57%
61%
32%
0%
6%
19%
47%
31%
44%
24%
22%
44%
36%
Company
WESCO International Inc.
American International Group Inc.
Wells Fargo & Co.
JPMorgan Chase & Co.
Ubiquiti Networks Inc.
Union Pacific Corp.
Generac Holdings Inc.
Realogy Holdings Corp.
Live Nation Entertainment Inc.
Eastman Chemical Co.
Flowserve Corp.
Rexnord Corp.
Anthem Inc.
Service Corporation International
Berkshire Hathaway Inc.
Wabtec Corp.
Carpenter Technology Corp.
Alere Inc.
Arista Networks Inc.
Team Inc.
Pegasystems Inc.
Digi International Inc.
As at date
Dec-15
Dec-15
Dec-15
Dec-15
Jun-16
Dec-15
Dec-15
Dec-15
Dec-15
Dec-15
Dec-15
Mar-16
Dec-15
Dec-15
Dec-15
Dec-15
Jun-16
Dec-15
Dec-15
Dec-15
Dec-15
Sep-15
Source: FactSet Research Systems Inc.
Not only do many of the companies above have significant revenue coming from outside the U.S. rendering the
geographic categorization meaningless, risk is minimized by the simple fact that none of these companies are in
our Portfolio for the same reasons. Like sector allocations, geographic ones don’t really inform investors on their
risk exposure. Head office location means little more than what country the CEO buys his/her morning coffee in
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before heading to the office each day.
Save your fork
If we had to use a chart to illustrate how diversified our Global portfolio is, we’d highlight the unique ideas we
have about each business, not what sector it falls in or where its head office is. It would look something like this:
Company
Business
Our idea
🚚
WESCO International Inc.
Product distribution
Opportunity for margin expansion
💰
JPMorgan Chase & Co.
Largest East coast bank
in the US
Potential to grow book value 10% per share, per year
even in a slow growing economy
📡
Ubiquiti Networks Inc.
Communication
infrastructure support
Direct to customer approach cuts out costly middleman
and sales team that burdens competitors
🚄
Union Pacific Corp.
Rail company
Pricing power due to inflation in the trucking industry
🎸
Live Nation Entertainment Inc.
Concert promoter/sales
Unparallelled live entertainment platform that hasn't
been fully monetized
⚙
Rexnord Corp.
Manufacturing
infrastructure
A platform and management team that should
compound our investment over time
💐
Service Corp.
Funeral services
Large scale allows many advantages over time
We certainly don't own a piece of everything, like index funds or our closet index peers largely because there’s
evidence to show there’s benefits to holding a relatively small number of stocks, say between 20 and 40 at most.
In fact, investment managers whose portfolios are concentrated in their best ideas have consistently
outperformed more highly diversified portfolios often without added risk.* Seeking safety in a pie rarely leads to
investment success. We’d suggest safety lies in well-researched investment ideas because the more you know
about a business, the greater your advantage over others. This helps in identifying mispriced securities, which
creates opportunities to outperform while decreasing risk. Even a single business can provide all the
diversification you need assuming it’s varied enough in its holdings and operations and you bought it at the right
price.
Don’t get us wrong, we believe diversification is important though we believe diversifying by business idea is a
much more effective way to manage risk especially when compared to colours on a pie chart. Each one of our
investments is based on a well-researched proprietary idea. Our investment managers go to great lengths to
ensure that the collection of businesses in the portfolios isn’t based on the same or similar ideas. Thus, our
portfolios – while concentrated – are diversified. Any way you slice it, investors shouldn’t focus too much on
owning a bit of everything but instead owning the right things.
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*Randolph B. Cohen, Christopher Polk and Bernhard Silli, Best Ideas, MIT, London School of Economics, Goldman Sachs, May 1, 2010.
Commissions, trailing commissions, management fees and expenses may all be associated with mutual fund investments. Please read the
prospectus and Fund Facts before investing. Copies are available from your financial advisor or at www.edgepointwealth.com. Mutual funds are
not guaranteed, their values change frequently and past performance may not be repeated. This is not an offer to purchase. Mutual funds can only
be purchased through a registered dealer and are available only in those jurisdictions where they may be lawfully offered for sale. This document is
not intended to provide legal, accounting, tax or specific investment advice. Information contained in this document was obtained from sources
believed to be reliable; however, EdgePoint does not assume any responsibility for losses, whether direct, special or consequential, that arise out of
the use of this information. Portfolio holdings are subject to change. EdgePoint mutual funds are managed by EdgePoint Investment Group Inc., a
related party of EdgePoint Wealth Management Inc. EdgePoint® and Owned and Operated by Investors TM are registered trademarks of EdgePoint
Investment Group Inc. Published December 7, 2016.
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