London-based investment skills consultancy firm Inalytics analysed 599 equity portfolios and found that the portfolios from the lowest quartile, in terms of the number of holdings, performed more than 400 basis points better than those in the quartile with the highest number of holdings.
Inalytics founder and chief executive Rick Di Mascio said the research clearly showed fund managers that invested in a smaller number of stocks outperformed their counterparts, and put forward several suggestions that may explain the findings.
“One possible rationale is that only the most skilful managers are given the punchier portfolios to run. A good analogy is that only the very best racing drivers get to drive Formula 1 cars,” he said.
It could also be more experienced managers gain the confidence to tackle riskier, more concentrated portfolios.
Mr Di Mascio also posited a self-selecting, natural attrition style explanation whereby, of managers attempting to run more concentrated portfolios, the less successful or less skilful fall by the wayside, leaving only the more skilful managers in that part of the market.
“Once again there is a parallel with the Formula 1 drivers, but at least in the case of fund managers it isn’t dangerous,” Mr Di Mascio said.
The third possible explanation, according to Mr Di Mascio, was that the more concentrated portfolios are able to be given a greater amount of attention per holding.
“From a behavioural finance perspective, the literature suggests that the lower the number of holdings in the portfolio, the more attention each one receives,” he said.
“Whatever the explanation, the data is clear – the more concentrated the portfolio, the more likely the performance is going to be good.”
