Desire to stand apart and outperform spur more concentrated portfolios — and mixed results
The need for diversification as a way to achieve safety is a fundamental notion in investment. But an increasing number of stock pickers appear to be abandoning that idea as they build smaller, more concentrated portfolios.
“Part of the idea is to differentiate themselves from the low cost, index-tracking exchange-traded funds that have done so well during the 10-year bull market,” reported the Wall Street Journal.
Citing data from Morningstar Direct, the Journal said that the number of active US stock funds with fewer than 35 stocks has nearly doubled since the start of 2009; the percentage of active US stock funds that are concentrated based on that benchmark has risen from 7.6% to more than 9%. The AUM in such funds has also nearly tripled to reach US$161 billion by the end of October.
But over that time, equity portfolios with fewer than 35 stock holdings have lagged both the S&P 500 as well as their more diversified peers. Portfolios that were even more highly concentrated – those with 20 stocks or fewer – have underperformed to a greater degree, returning an average of 133% percentage points less than the total return of the S&P 500.
Those who support concentrated portfolios maintain that they allow investors to focus on only the best ideas. Barry Gill, head of equities at UBS Asset Management, noted a belief that portfolio composed of a few carefully chosen, high-quality companies can have similar risk-lowering benefits as a larger, more diversified one.
“I believe it’s inevitable that if you fast forward 10 to 15 years, the bulk of surviving active strategies in developed markets will be high-concentration portfolios,” he said.
Some have asserted that concentrated strategies can do better during downturns. In the 2008 financial crisis, active US funds with fewer than 35 stockholdings fell around 2 percentage points less than the average US equity fund. But they also lagged behind the S&P 500 by 0.7 percentage points.
Performance has been likewise mixed in more recent sell-offs, the Journal noted. While concentrated funds did better than their diversified peers in 2011, they also lagged the S&P 500. Such funds lagged both the broad market and more diversified funds; in 2018, they did better than other active funds, but still fell further than the S&P 500.
Richard Cook of Cook & Bynum, who oversees US$114 million in the firm’s Cook & Bynum Mutual Fund, told the news outlet that investors in concentrated funds “don’t think bull markets last forever, and they think there will be a time when stock pickers have an advantage.”
The mutual fund currently holds just eight stocks, including Anheuser-Busch InBev and a Chilean company that bottles and supplies drinks under license from Coca-Cola. Cook and Bynum’s institutional fund, whose strategy closely mirrors the mutual fund’s, showed better-than-market performance during and immediately following the financial crisis.
But over the last 10 years, the fund has lagged behind the S&P 500, returning 73% versus 254% for the blue-chip index.
