A: We are trying to beat the market with a diversified portfolio and this is very difficult. Most active managers beat the market by focusing and taking larger risks. They focus in an area where they have some industry expertise that helps them to do better than average. But when you start to run a very narrow portfolio, by definition, you have a more volatile portfolio. We, on the other hand, have so much talent that we are not limited to any single sector or trend. In fact, I like it better when drivers behind the stocks are independent of each other, even if they are going in opposite ways.

Overall, every stock in the portfolio has to have a good reason to be there on its own. We don’t add any stock just to get diversification. If we don’t have a strong case that it can double in two years, then it doesn’t deserve a big position. The ideal portfolio is a set of best-idea stocks that collectively are in more than one sector and are dependent on different factors. That’s how we bring diversification and still maintain the potential for great returns.

Q:  How many stocks do you have in the fund?

A: We have 250 stocks right now. We are going through this process of looking at the big holdings to see whether they warrant being big or bigger holdings. As we work through the list, we are willing to make bigger bets on the best ideas and there’ll be fewer holdings. But I’d be surprised if we ever got down to less than 100 stocks.

Q:  What is your view of big positions?

A: Any stock that is more than 5% of the portfolio is a big position. One investor, whom I have been tracking for almost six years, has 27 positions in his portfolio right now. He has probably had over 100 positions over the last six years and he has made many buy and sell decisions.

Of all of the stocks that this investor has ever touched in his portfolio, 79% made money 21% lost money. The ratio between the average loss and the average gain tells you how well he is doing cutting off his losses, and the ratio for this investor is two. This means that when he picks a stock that turns out to be a winner, he makes twice the money he loses on a stock that turns out to be a loser. And he has a lot more winners than losers.

So, we are betting on an investor with a great track record. When he picks a stock, especially one that he chooses to make a large part of his portfolio, then we put it out to the broader community to see if we can flush out the idea and help him to either have more conviction on this stock or to clear some issues so that he can get out with a smaller loss.

When you have investors like that, there are many stocks that are candidates to become 5% of the portfolio just on the strength of conviction. But, I would not let any stock become a big position unless we have conviction from a more extensive research process that involves tapping the broader Marketocracy community.

A large number of the stocks in our portfolio are very small positions where we are using the judgment of these investors. There are about eight to ten positions that are big enough after we put them through the whole research process.

Q:  What is your view on risks and how do you mitigate them?

A: The industry usually defines risk as the volatility of the portfolio or the tracking error. I think of risk as the various factors that drive the doubles in each of these companies, and as a list of factors that would be disasters for these companies.

Risk control is, first of all, making sure there is no single risk that affects all the stocks in your portfolio. It’s not a volatility argument but an assessment about what conditions in which the portfolio does well or poorly, and making sure that your portfolio is constructed such that there is no single factor that can knock down all the positions. The more diversified the portfolio is across different driving factors, the better I feel.

For example, right now, people are worried that the energy level is topping. Many people are trying to get out before the rest, and that’s making oil stocks weak. I think there is a real risk, but the very best people are actually buying more of the refining stocks. I’m willing to follow their lead but only up to a degree, because I don’t want the whole portfolio to come falling apart should oil tank. I am keeping the energy sector less than 25% of our portfolio.

So, although we would have some great investments in the energy, unlike an energy fund, which must invest in energy our portfolio could do well even in the disaster oil scenario. Although we have some biotech stocks, we buy them because we like the drugs they are launching. These are not sector bets but are company bets. The important thing is that the returns are going to be independent of the industry.

There are four or five areas where there are active bets that would do very well if everything worked out well. I’m not betting that we are going to be right on everything. In fact, I’m sure that we are going to be wrong on some things. But because of our research process, I’m confident that our portfolio is going to be more right than wrong.