David Allen

The idea that a fund manager must hold a concentrated portfolio to significantly outperform the benchmark is an enduring investing legend.

However, when you look at the data, this widely held conclusion seems somewhat questionable. Afterall, Renaissance Technology, the most successful hedge fund of all time has generated returns in excess of 70 per cent p.a. before fees and has several thousand positions at any one time.

So, let’s dig in a little deeper.

Have concentrated managers generated superior performance to diversified managers on average over time?

The star manager effect

For decades, the idea of the “star fund manager”, with a perceived extraordinary ability to identify the super compounders hiding in plain sight, has reigned supreme.

Typically, the portfolios of star managers have been concentrated with less than fifty holdings.

The chart below shows the average performance of global equity funds vs. the MSCI World by number of holdings over the last two years. For this analysis we took every global equity fund in the Morningstar database that reported holdings and performance data.

The results are striking. The most concentrated portfolios, holding less than 25 stocks imploded, underperforming by an average of 11.1 per cent over 2022 and 7.5 per cent p.a. over both 2021 and 2022. Portfolios with 25 to 50 holdings also underperformed. These averages obscure some rather frightening underperformance from individual funds, with several underperforming by 30, 40 and 50 per cent.

Source: Plato Investment Research, 12/22

Yes, Buffett has long rallied against the evils of “diworsification” – arguing that one should instead put all their eggs in one basket and watch that basket. However, this model has come crashing back to earth with many marquee managers underwater versus their benchmarks not only in 2022, but since inception.

The longer-term evidence

You could argue the above chart doesn’t provide a conclusive illustration of the performance of high concentration, covering a period which was predominately a bear market.