Howdy, Stranger!

It looks like you're new here. If you want to get involved, click one of these buttons!

In this Discussion

Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.

    Support MFO

  • Donate through PayPal

Thoughts on Concentrated Funds Marketing

edited March 2023 in Fund Discussions
I’ve seen some great concentrated funds and many terrible ones, which is inevitable as both the opportunities and risks increase with concentration. But I do sometimes wonder at the marketing of these funds. Invariably I hear/see things like “these are our best ideas” and why would you put money into your 30th best stock instead of your first?

But I often wonder if the marketing of some of these funds isn’t terrific spin to make what is really a drawback appear to be a strength. The drawbacks could be in some cases limited research capacity, intellectual laziness, overconfidence and a lack of imagination. In other words, there are literally thousands of stocks to investigate and consider, but this fund manager thinks there are only 20 or 30 worth considering. They may actually not think that but be unwilling to admit they only have two or three analysts and simply don’t have the resources to cover other companies. They also may want to swing for the fences with just a handful of stocks hoping to have a big year to draw your assets and hey it’s not their money but yours at risk.

It is often boutique managers running these concentrated funds. I’ve seen a handful that have also been really good at risk control, and it’s impressive and important to pay attention to. But I think it’s worth noting that there are managers who do have the resources to cover thousands of stocks. Fidelity’s 100th best idea may prove better than the boutique manager’s twentieth or even first. At the least, their hundredth will expose their investors to less unique potentially devastating business risk than a concentrated fund’s.

Most of the funds where I have found concentration has worked best are those that focus on a unique factor--quality. They invest in dominant businesses with strong balance sheets and reliable cash flows. That insulates the portfolio from idiosyncratic business risk. They also don't overpay for these companies. Yacktman and Jensen come to mind. Yet a number of other strategies I've seen backfire in concentrated styles--deep value in distressed companies, aggressive growth in unproven story stocks and small or microcap stocks where the companies only have one line of business.

Comments

  • @LewisBraham, have you ever come across any evidence that one or the other, concentrated or not funds, outperform the other on average? Since most funds don't perform better than an index, it would be my guess that on average concentrated funds don't outperform and may be more volatile. But that's just a guess. I have no idea. Managers of concentrated funds would have to be uniquely talented stock pickers I would think (which I'm sure there are a few).
  • edited March 2023
    Often the research on concentration relates to that of "active share" as a metric in funds as the more concentrated a fund is, the more it tends to differ from its benchmark, having thus a high active share. Yet the two concepts are not synonymous. Still, the Morningstar research on high active share found it not to be useful in predicting future outperformance: https://morningstar.com/lp/unattractive-share What it predicts is future extremes in performance, extreme outperformance or extreme underperformance, which makes sense. What Morningstar also found is that high active share funds charge more fee wise for "their best ideas" and that, every study indicates, leads to underperformance on average. Of course, concentrated funds are rarely average, either great or terrible, or sometimes great, then terrible--see CGM Focus or FAIRX.

    The other issue is that even successful concentrated funds can be volatile with big upswings and downturns. That the research indicates can lead to poor "investor returns" in that investors are terrible trading such funds, buying them at their peaks and selling them at the bottoms. So, even if a concentrated fund is good, investors may not enjoy the good times in it. That's why I think with concentrated funds it's essential for all but the savviest traders who can time their purchases well to study the fund's risk stats and seek out the concentrated fund with good downside protection and lower volatility overall--generally the high quality focused funds.
  • Thanks Lewis. That's great insight.
Sign In or Register to comment.