Portfolio Risks and The Mortgage Sector

It occurred to me this week, in the midst of the continuing meltdown of the sub-prime mortgage lending sector, that my portfolio selection process exited the homebuilding and (prime) mortgage sector over six months ago. Happily, we own no mortgage or homebuilding sector stocks anymore.

I recall, however, back in 2005, that the business media was screaming about the sector's imminent collapse. At the time, a prominent fund allocator, with whom I had discussions, in hopes of attracting investments, complained that my strategy was overconcentrated in the homebuilding and mortgage sector. My response was that, to earn returns, you had to choose what was going to do well, and devote resources to those areas, rather than to mindlessly diversify. Rather like Kirk Kerkorian's own philosophy, mentioned in this post,

"Diversification is for people who aren't sure about what they are doing."

Over the time period stretching from mid-2003 to mid-2006, my selection process had selected companies in these sectors which returned a total of 4.8%. By July of last year, however, the process had rinsed mortgage lending and homebuilding out of the portfolio.

Now, everyone is worried about the sub-prime lending sector and, by extension, the homebuilders. The market's damage to the former group is making the pain felt by the conventional home building and lending equities in late 2005 and 2006 look tame by comparison.

This is a fine example of how our equity portfolio strategy and selection process' risk management has performed. As the sector's constituent companies began to underperform, both fundamentally and technically, our process had us exit the sector way before real damage occurred, and we made money on the sector over the time in which we were invested.

I wish I could speak with the analysts from that fund allocator again, now. As it happens, I heard from a friend that they sustained some heavy losses in the past year. I guess their own risk management wasn't quite up to snuff, after all.