Investing with a high-conviction manager may sound prudent. Watering down exposure to a manager’s best ideas seems like it would only lead to mediocre performance, making it harder to recoup active fees. But increasing portfolio concentration also increases the risk of missing out on some of the market’s big winners, which have historically driven a disproportionate share of its returns.
A recent study I published shows that, in practice, these factors appear to offset. There isn’t a significant relationship between portfolio concentration and gross returns among U.S. equity mutual funds. Yet, concentrated managers tend to charge more, and the risk of manager selection is greater for these funds because of the wider range of potential returns between winners and losers. Investors in concentrated funds should be mindful of the risks and not give managers much leeway on fees.