Concentrating On Concentration: New Data On Portfolio Concentration

As most of our readers know, we are proponents of more concentrated portfolios. In May of 2017, we released our Concentration Manifesto which was an attempt to get a critical dialogue started between managers and allocators to ultimately improve the active management process. A conversation that requires both sides cast aside outdated thinking and embraces the notion that concentration is in their best interest.

And we’re seeing it in external data:

And in our own managers:

This conversation began well before our Concentration Manifesto. We recently found an April 2014 study by Cambridge Associates outlining the “Hallmarks of Successful Active Equity Managers.”

Cambridge Associates analyzed a selection of managers to isolate attributes that lead to success. In their findings, active share and concentration were major contributors. Their analysis¹ found that concentrated portfolios (US equity less than 30 positions and US Small-Cap & EAFE Equity less than 40 positions) generated between 100bps and 170bps of additional performance over non-Concentrated portfolios.

The performance difference for concentrated managers held after fees and worked across various strategies. The fractal nature (it still works when you break it into different strategies) lends additional validation for concentration’s benefits.
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In the Cambridge article, we found a reference to another concentration study.
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Baks, Busse, and Green published “Fund Managers Who Take Big Bets: Skilled or Overconfident” in 2006. The abstract says it all:
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We document a positive relation between mutual fund performance and managers' willingness to take big bets in a relatively small number of stocks. Focused managers outperform their more broadly diversified counterparts by approximately 30 basis points per month or roughly 4% annualized. The results hold for mimicking portfolios based on fund holdings as well as when returns are measured net of expenses. Concentrated managers outperform precisely because their big bets outperform the top holdings of more diversified funds. The evidence suggests that investors may enhance performance by diversifying across focused managers rather than by investing in highly diversified funds.

Their sample covers funds from 1979-2003 and the return advantage per month ranges between +1 and +67 basis points depending on the methodology for measuring fund concentration and how many deciles to included. That equates to a range between +0.12% and +8.34% on an annualized basis for concentrated managers.

We continue to believe that there is a demonstrable skill in equity managers and that the skill could be harnessed in better ways than is typically demonstrated by the average manager and that concentration is the simplest way to improve a manager who possesses positive stock-picking skill.
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¹ eVestment Alliance Database: September 2007 to June 2013 US large-cap core equity, US large-cap growth equity, US large-cap value equity, US small-cap core equity, US small-cap growth equity, US small-cap value equity, and all EAFE equity
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Download full version of the Concentration Manifesto

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