Highly concentrated portfolios perform better than diversified ones, according to research by the London-based investment skills consultancy firm Inalytics.
Chief Executive Officer and founder of Inalytics, Rick Di Mascio, says that the research shows that when fund managers invest in a small number of stocks they outperform their counterparts investing in a larger number of stocks.
“When we did the numbers, it reveals the portfolios with the lowest quartile of holdings performed over 400 basis points better than the highest quartile of holdings,” he says.
Information for the research came from Inalytics’ database of 599 equity portfolios. The database was divided into quartiles.
The research originated from Inalytics’ Client Inspired Research where its clients are asked to pose a question to be investigated. In this instance the Royal Berkshire Pension Fund in the UK posed the question.
Di Mascio advances three explanations for the research findings.
“One possible rationale is that only the most skillful 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.
“Another explanation is that the database may be biased towards successful managers who were given the opportunity and ‘survived’. Once again there is a parallel with the Formula 1 drivers, but at least in the case of fund managers it isn’t dangerous.
“Third, from a behavioral finance perspective, the literature suggests that the lower the number of holdings in the portfolio, the more attention each one receives.
“Whatever the explanation, the data is clear – the more concentrated the portfolio the more likely the performance is going to be good,” he says.