A series of articles by Motley Fool analyst Mike King on how to setup a diversified portfolio reminded me of a basic risk management tool enforced upon professional fund managers all across Europe.
Diversification when building a portfolio is key to managing downside risk and European fund managers who wish to offer managed funds to retail clients are generally legally obliged to follow what is known in the industry as the 5/10/40 rule.
5/10/40
The rule means that no single holding shall consist of more than 10% of the portfolio's net value, while no five holdings shall consist of more than 40% of the portfolio's net value.
This is a conservative risk management tool for defensive investors to follow and almost guarantees that a well constructed portfolio will ride out the consequences of disastrous performance from any single investment.
For example you could have 4 holdings up to 10% and 5 holdings up to 8% to make up 9 holdings across 80% of your portfolio. The remaining 20% is made up of around another five stocks. Anything more concentrated is probably insufficiently diversified.
Here are three stocks with strong prospects on attractive valuations that you could consider adding to your diversified portfolio today.
Veda Group Ltd (ASX: VED) $2.30 – Is a data and credit analytics business that has climbed steadily since going public as a company in late 2013. Veda has posted rock solid revenue and profit growth over the years and enjoys the advantages of a data driven digital future.
Clients use the company's services due to the perception that it offers the best quality data analytics and this is what provides Veda a moat and advantage to retain it's market-leading position. The valuation is reasonable and the growth potential palpable.
Trade Me Group Ltd (ASX: TME) $3.66 – Is a wildly popular website in New Zealand that deals in property, cars, jobs and other classified advertising.
Trade Me's dominance provides a moat via the network effect where buyers and sellers gravitate to the most popular website. In fact Trade Me's so popular it's the fifth most visited website in New Zealand behind Google NZ, Google, Facebook and YouTube!
The business is diversifying into travel, insurance and financial services, while maintaining a rock solid position in the digital future. The valuation is reasonable and the long-term future solid.
Rea Group Limited (ASX: REA) $49.03 – As the operator of Australia's most popular property website reaestate.com this business probably needs no introduction to most Australians. It also enjoys the benefits of the network effect and has direct to leverage to one of the most potent asset classes known to mankind in property.
It's also expanding in the US market, Europe and via an interest in Asian property group iProperty Group Ltd (ASX: IPP). The best businesses always seem expensive, but REA Group's valuation looks reasonable looks reasonable given the growth potential.
