Mutual funds that hold a relatively large number of positions are often thought to have less risk than funds that hold fewer positions. However, studies have shown that concentrated portfolios, generally those with fewer than 25 portfolio holdings, do not have a higher risk profile and can provide meaningful performance advantages over time.
A review of academic studies shows the following:
High Conviction Investment Ideas Have Outperformed
The investment ideas in which active mutual fund managers had the greatest conviction consistently outperformed the rest of the positions in their portfolios and the market, between 1984 and 2007, by about 1 to 2.5 percent per quarter, depending on the benchmark.1
Highly Concentrated Funds Have Outperformed
Mutual fund managers willing to make “big bets” by concentrating their portfolios’ assets have outperformed managers of more highly-diversified portfolios. In a study known as, ‘Big Bets,’ it was found that domestic stock portfolios with large weightings in a relatively small number of holdings delivered higher returns—both before and after expenses—than portfolios which held more uniformly weighted positions. These focused, “big bets” portfolios delivered approximately 30 basis points of additional performance each month, or roughly 4 percentage points of additional return each year.2
Focused Funds Have Not Exhibited Higher Risk
Some investors may believe that concentrated mutual funds expose investors to greater risk than more highly-diversified options. While systematic risk cannot be eliminated, research has shown that holding 20 stocks can significantly reduce unsystematic risk (see Chart 1).3