What is a Concentrated Fund and Is it Right for You?

Funds that do not own many stocks are often referred to as concentrated (or focused).  Many of these funds have only 25 – 50 stocks.  While on the other end some funds own upwards of 1,000 stocks.

Funds with Few Stocks

When you have a concentrated fund you can have higher risk.  The more stocks that a fund has the smaller the impact of a bad investment on the overall return.  When a fund has 25 stocks and one of them does bad, the impact is bigger on returns than if the fund has 100 stocks.

On the other hand, you can have a less risky portfolio with fewer stocks based on what stocks and what sectors the manager is investing in.  Not all concentrated portfolios are risky it depends on their make-up.

Funds with Many Stocks

When you have a fund that has 250 stocks, you run the risk of the managers not knowing what is going on with each holding.  250 Stocks is a lot of companies to keep up with.

In addition you could still have a highly risky portfolio even with 250 stocks.  This comes from that fact that diversity is more than just a large quantity of stocks.  You need to have different sectors, different sized companies, different companies, and industries in order to have diversity.  I own a health industry mutual fund that has 158 stocks in it.  This is not diversified, it only owns one industry.  On the other hand I own a mutual fund that has 44 stocks but covers 6 industries in two different capitalization areas – this is diversified!

How to Decide what is Right for You

1. Does the mutual fund have a position greater than 10% in any stock?  10% is a good rule of thumb to keep your exposure limited to on a single stock.  This is a good thing to keep in mind not just for individual mutual funds, but your fund as a whole also.  Do you have overlapping mutual funds that forces you to have over 10% in a stock? (Morningstar portfolio management can help you with this).
2. What are the fees like?  Fees still have a large impact on your investment no matter how many stocks are in the fund.  If the management fee is high you are better off looking elsewhere.
3. What is the volatility of the historical returns?  Does it have a few great years and then sit with no gains?  Many concentrated funds are more volatile in the short term yet perform in the long run.  Can you stomach this up and down?
4. How many managers run the fund?  Does the fund have 8 managers and 200 stocks?  This is only 25 stocks per manager, not as overwhelming as 2 managers looking after 100 stocks each.
5. Is this going to be a core holding for you?  Are you willing to have fewer stocks with this being your primary investment?
6. What do the other risk measures say?  Just because they have a smaller stock holding does not mean that it is riskier.  I have a fund that has 44 stocks and another that 430 stocks.  The one with the 430 stocks has a higher beta and standard deviation.   You need to remember to look at the whole picture not just one aspect.

This is not a black and white issue that you can quickly decide yes you only want concentrated funds.  Many factors play into if a concentrated fund is right for you and your portfolio.

Looking at all of these aspects will give you a better idea of how the number of stocks in a portfolio works for you and your needs.