Playing Portfolio Favorites
The mutual fund industry grew to the behemoth it is today in part by stressing to small investors the merits of diversification.
Yet some of the most successful stock funds of recent years have been very un-diversified--at least compared with most of their peers.
Technically, these concentrated portfolios are known as “non-diversified” funds. Despite the nomenclature, it doesn’t mean they invest in a single sector or industry, although there are concentrated funds that do.
Non-diversified funds simply have more leeway in limiting their investment choices because they’re not subject to the diversification rules governing most stock funds. The non-diversified funds generally hold 50 stocks or fewer; in many cases they hold fewer than 30 stocks at any given moment.
“These funds have a story that sells,” says Stephen M. Savage, editor of Value Line Mutual Fund Survey in New York. “You’re supposed to get only the [fund manager’s] best ideas, which is great.”
But, he points out, “the best ideas don’t always generate the best returns,” and the smaller number of holdings may sharply increase a fund’s volatility and risk, especially in the short term.
Be that as it may, several successful funds have been managed in this manner for years, including the Clipper Fund, Longleaf Partners, Papp America-Abroad, Strong Schafer Value and CGM Capital Development.
Says Philip W. Treick, manager of the new non-diversified Transamerica Premier Aggressive Growth fund: “Let’s be honest, there are only so many good ideas a manager can come up with. I’d think an investor would prefer for me to focus on the best ideas, rather than on a bunch of stocks I don’t believe in so strongly but which I own only to meet diversification rules.”
More fund companies have hopped on the non-diversified bandwagon recently with at least one such offering.
“Up to about a year ago, there weren’t many funds specifically put out as concentrated funds,” says Ken Gregory of Litman/Gregory Fund Advisors, a San Francisco firm that recently unveiled its own such fund. “With a concentrated approach, you have a much better shot at beating the Standard & Poor’s 500 if you’re a skilled stock picker.”
But do these funds in fact deliver those S&P-beating; returns? Many have.
So far this year, such non-diversified funds as Oakmark Select, Montgomery Select 50, Sequoia and Janus Twenty have topped the S&P;’s total return of 27%.
And measured over the last five years, such veteran non-diversified funds as Clipper, Sequoia and Longleaf Partners have beaten the S&P.;
But over the last two years the S&P; has proven to be a tougher hurdle for most of the non-diversified funds.
Although they share the general strategy of concentration, non-diversified funds often are dissimilar in their specific strategies. Investors interested in these funds should carefully read the prospectuses that detail how the funds invest.
Some concentrated funds own those stocks favored by a fund family’s entire investment team.
Oakmark Select, for example, which made its debut Nov. 1, 1996, holds no more than 20 stocks, which manager Bill Nygren selects from Oakmark’s “approved” stock list. He can include issues of both large and small companies in the fund.
The Montgomery Select 50 Fund, launched Jan. 1, 1996, consists of 50 stocks, with each of the firm’s five investment teams choosing 10.
“You get a focus at the stock level and diversification among five different disciplines,” says Kent Baur, director of portfolio research at Montgomery in San Francisco. “It’s the best of both worlds.”
Montgomery’s teams focus on three types of U.S. stocks and two varieties of foreign firms. “Under normal conditions, we expect each sub-portfolio [of 10] will outperform its more diversified mutual fund cousin,” Baur says.
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Several of the non-diversified funds are run by managers who have a distinct “value” approach to investing, which means they hunt for stocks they believe are priced below a business’ intrinsic long-term value.
Funds in that category include Clipper, Strong Schafer Value and Yacktman.
Although those managers usually invest with great conviction in companies that they believe they understand very well--the Warren Buffett approach to investing--they also tend to take a long-term view. That means they may be content to wait for years for that value to be realized in the stock prices.
That also requires that the funds’ shareholders be patient--perhaps more patient than many are willing to be in an era when the focus so often is on short-term investment results.
What’s more, investors should realize that although concentration means that dramatic stock price gains by a few issues can lead to spectacular returns, a few bombs can badly wound these funds.
CGM Capital Development stumbled in 1994 when manager Kenneth Heebner made some bad sector bets. The fund lost 23% during a year when the S&P; 500 index gained 1%.
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Most experts suggest that concentrated funds be treated like individual stocks or sector issues when allocating assets within one’s portfolio. In other words, few investors would want to keep the lion’s share of their assets in these funds.
And don’t give that logical-sounding sales pitch about “the best ideas” too much weight. “These funds appeal to our base instinct to get the absolute most we can from the market,” says Michael Stolper, a San Diego investment advisor. “But chasing returns is a bad way to invest. You forget what happens when things go wrong.
“Just because every fund company may offer these soon doesn’t make these funds right for everyone,” he said.
Indeed, another way to think about non-diversified funds is like so: Since there can only be a handful of truly great stock-pickers in the world (otherwise, every manager would beat the market in the long run, which is impossible), even managers who say they’re focusing on their “best” ideas may not be savvy enough to choose stocks that will beat the buy-and-hold return of broad market indexes over time.
Russ Wiles is a mutual fund columnist for The Times. He can be reached by e-mail at russ.wiles@pni.com. Charles A. Jaffe is mutual fund columnist at the Boston Globe. He can be reached by e-mail at jaffe@globe.com
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Less Is More? Sometimes
These stock mutual funds have tended to keep their portfolios very concentrated in recent years, in many cases limiting their holdings to 30 stocks or fewer. How their performance compares with the Vanguard Index 500 fund, which tracks the Standard & Poor’s 500 -stock index:
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Two-year YTD annualized Fund return return Oakmark Select (800) 525-6275 +41.9% NA Montgomery Select 50 (800) 572-3863 +31.8 +31.0% Sequoia* +31.5 +31.3 Janus Twenty (800) 525-8983 +29.8 +30.2 Papp America-Abroad (800) 421-4004 +27.4 +29.4 CGM Capital Dev.* +27.2 +29.8 Longleaf Partners* +27.0 +23.6 Clipper (800) 776-5033 +25.0 +25.6 Vontobel U.S. Value (800) 527-9500 +25.0 +27.2 New England Growth (800) 225-5478 +25.0 +24.4 Yacktman (800) 525-8258 +16.0 +24.0 PBHG Select Equity (800) 089-8008 +4.7 +17.5 Vanguard Index 500 +27.0 +28.3
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*Fund is closed to new investors
NA: Not applicable (fund is too new)
Sources: Lipper Analytical, CDA Wiesenberger, Morningstar
