Don't Fear These Concentrated Funds
For these fund managers, the recipe for success means making bigger bets on fewer stocks.
Given the barrage of companies seeking financial rescue in this economic downturn, investors may be inclined to avoid concentrated funds because they could hold big positions in suddenly troubled firms. True, portfolios with scores of stocks may court less stock-specific risk, but managers of concentrated funds are forced to be disciplined and buy only the most promising stocks. Essentially, the manager can dig deeper into each stock in the portfolio and let his best ideas shine through.
While concentration is an effective tool, it needs to be in the right hands. Using the Premium Screener, we created a screen to find managers who have built strong long-term records using more-concentrated approaches. We limited the screen to domestic stock funds (excluding specialty-stock categories) with top-third trailing 10-year records, making sure that the current manager was responsible for that record. To zero in on concentrated portfolios, we required that at least 50% of assets be invested in the top 10 holdings. We also made sure that the funds had average or below-average Morningstar Risk ratings. (This rating assesses performance swings of a fund's monthly returns compared with category peers', and it penalizes funds more for downside swings because investors tend to be more sensitive to losing money than they are about earning big returns.) Finally, we required below-average fees and investment minimums of less than $10,000.
Click here to run the screen yourself. The Premium Screener returned the following results as of March 2, 2009:
Keep in mind that a concentrated fund's performance is unlikely to move in lock step with the typical peer, especially when the manager ups the ante by clustering the fund's holdings in a handful of sectors. But in general, we like the long-term prospects of the above-mentioned funds. This confidence hinges on the fund managers' risk controls and stock-picking skills.
For example, FBR Focus (FBRVX) is one of the slimmer portfolios on this list with around 25 stocks in the portfolio, and the fund's Morningstar Risk rating has consistently been below average over the past 10 years. For manager Charles Akre, maintaining a strict valuation discipline has served as an effective risk control in his search for fast-growing small-cap firms. Akre is a buy-and-hold investor, and given the recent market sell-off, his picks offer a better margin of safety as their share prices fell more than his estimates of their worth. Although some investors might balk at a fund that has more than 10% invested in a single holding, Akre has managed this fund's stock-specific risk well over the long term.
Large-growth fund Marsico Focus (MFOCX), with its roughly 30 holdings, has a bit more punch than some others on this list. This is because manager Tom Marsico buys into some companies with more-explosive growth, but he tempers the added level of stock-specific risk by investing most of the fund's assets in steady-growth firms that he will hang on to for several years. And because he blends his macroeconomic views into the investment process, he keeps an eye on the industry dynamics of shakier areas of the market, including the recently tumultuous financials sector. While he didn't have much exposure to that sector in mid-2008, he was working to understand the risks of those businesses so he could act quickly if the climate became friendlier. In this case, the concentrated portfolio has allowed Marsico's stock-picking to stand out, and we certainly think this is an intriguing option.
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Karin Anderson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.