One of the interesting issues with managing other people’s money is having to decide how exactly to allocate that money among projects.
At any given fund size, you need to decide whether you should do a small number of big deals or a large number of small deals.
All the theory points toward diversifying. After all, assuming that all projects have similar return characteristics, if you spread the money among many projects, 1-2 going badly won’t destroy your results. And, indeed, the docs governing many investment funds require that they refrain from allocating more than a certain percentage of their equity to any given deal for exactly this reason.
But real life, of course, can be more complicated than theory, because:
- Sometimes (not often, but sometimes) the larger project(s) promise better returns than the smaller ones that are available at a given time; and
- In our business, which is extremely hands-on, managerial attention is at a premium, so spreading it among many, smaller deals may mean worse performance than if the attention were concentrated on fewer, larger deals
So, what do we do? We:
- Keep in mind that, all things being equal, diversification is better;
- Are willing to concentrate, because we:
- Limit ourselves to deals where we believe there is a considerable margin of safety (eg deals that are sufficiently profitable to absorb bad news)
- Limit leverage, which is the factor most likely to lead to disaster in our business
- Refrain from doing deals on brick- and un-reinforced soft-story buildings (because these can both collapse in earthquakes, the other major risk)
Will the above prevent us from losing money for our investors? No. There is always the chance we screw up. But we believe the above gives us a reasonable degree of safety while allowing us to chase attractive returns (which, after all, is the whole point of doing this).