Pondering the Portfolio 2

Last time I pondered sectoral allocation for equities. This time I'm going to talk about allocation by size. Like most investors, I started off buying shares in large, relatively "safe" companies and then moved on to smaller ones. In no way has my buying been consciously influenced by any desire to hold particular ratios of market size. I never think "Hmm, I really must increase my small cap holding by X%."

However, I thought it would be interesting, to me at any rate, to break down my holdings (all UK London Stock Exchange) into the standard maket capitalisation bands. They are as follows:

Me:       AIM   2%,       FTSE Small   11%,      FTSE 250   37%,        FTSE 100   50%

LSE      AIM   4%,       FTSE Small    2%,       FTSE 250   13%,        FTSE 100   81%

From this it's obvious that I have more in the way of small and medium sized companies than the market aggregate and that I am lighter on the riskier stocks of AIM (Alternative Investment Market). Also, in case you are wondering, the allocation of 50% of my holdings to the FTSE 100 is entirely fortuitous and not in any way intended. It's just where I and Mr. Market happen to be at the moment.

I think I am relatively happy with my current ratios and I cannot see them changing much in the short term. I do not consciously think much about size allocation but I suppose I do have a rough sense of balance between larger and smaller companies. I am pleased to see that my allocations differ significantly from the LSE ratios, otherwise it would be difficult to justify holding stocks at all rather than just a collection of index trackers. I like to cherish my illusion of stock picking prowess.

In an ideal world, small companies will become large companies and thus you should only ever need to replenish from the small caps, funding this by judicious selling of large caps, but it's also easy to make a small fortune from a large one. Companies that have done well in the past, i.e., larger ones, often tend to continue doing well, albeit at a slower growth rate. This is the essential case for a policy of buy and hold which, in my view, should comprise a major plank of any investment strategy.

I am not very keen on AIM since the relaxed accounting and reporting rules for this market significantly elevate risk for the small investor. I speak from bitter personal experience here. The chief danger comes not from the inherent trading risk of the companies concerned but from the fact that these companies and their advisors frequently exclude small investors from involvement in corporate actions. For example, major dilutions of stock can occur through share placings with institutional investors over which the ordinary shareholder is given no option to buy or sell. In other cases, mergers and takovers can take place where the usual default option of an enforced buyout is not on the table. If you have shares in an AIM company, always, always read the long boring document regarding any corporate action in full or else you could be out of pocket. There will be a wealth warning somewhere, but it's likely to be a footnote on page 101.