What’s the ideal number of stocks in a fund?
Buy too many, and you’re an index-hugger; buy too few, and very soon things may blow up in your face.
While fund managers must tread the line carefully, we wondered if DFMs have any particular predilection on the position sizing and concentration of stocks within the funds they choose.
Ucits rules dictate that no single stock can comprise more than 10 per cent of a fund’s assets, and that holdings above 5 percent can’t in aggregate exceed 40 per cent of the total.
In other words - the 5/10/40 rule.
However, this still allows for a fair bit of conviction-based investing, so Asset Allocator decided to conduct the beginning of a deeper dive into the beliefs of popular equity fund managers in our database.
We grabbed 10 of the most popular funds owned by the DFMs we cover and looked into two things: how many stocks each fund holds, and their active share percentage.
As a reminder, active share is supposed to gauge the difference between a portfolio's holdings and its benchmark.
Here’s what we found.
Shhh, concentrate
So it turns out the average number of holdings across these 10 behemoth mandates is 52, around slap bang in the middle of the spectrum between concentration and dilution.
It may come as no surprise to our readers to note that Lindsell Train UK is by far the most concentrated mandate – given it’s not actually governed by Ucits rules.
However, Train himself has occasionally found himself in hot water with the UK regulator after his position sizes grew too large, but for now he holds five holdings of near-10 per cent: Unilever, LSEG, Relx, Experian and Diageo (plus one more: Sage Group at just below nine per cent).
Fundsmith is close behind with 29 holdings of fairly significant weight, and perhaps it’s a peculiarity of our results that this global fund – which by definition has the highest number of companies to choose from – has taken the highest conviction of any other Ucits mandate in our study.
At the other end of the spectrum, JP Morgan US Equity Income holds the grand total of 85 companies, although with longstanding manager Clare Hart due to retire in the autumn, we wonder whether this will change significantly.
Position sizing can be pretty idiosyncratic when comparing apples to apples – Evenlode Income and Man GLG Income, two comparable UK dividend payers, differ greatly in their distributions. Evenlode holds 38 firms, while Man GLG holds 62.
Coming to active share now. The average of these 10 funds is 77 per cent, with, thankfully, none of the mandates under scrutiny dropping below the dreaded 60 per cent mark, the line at which its inventors believe to constitute index-hugging.
Conversely, the plurality of these funds achieve over 80 per cent active share, meaning they’re much more likely to diverge from the benchmark than not.
What does the industry think?
James Sullivan, head of partnerships at Tyndall, thinks that managers should always lean into their beliefs, but not to the extent that they are all-in.
“I am an advocate of diversification for the simple reason that we should have enough humility to recognise we may be misguided with our convictions,” he said. “The wealth and commercial risks of being wrong for too long can be catastrophic, and therefore finding a balance is key.”
As such, Sullivan varies the extent of conviction depending on the price of the market at that particular time – in more expensive, or more efficient, markets, strong stances are preferred.
He added that the 5/10/40 rule is there for all the right reasons but can see why some fund managers find it restrictive.
Charles-Henry Monchau, chief investment officer at Syz Group, told Asset Allocator that one of the benefits of more concentrated funds is the opportunity for higher potential gains.
Investment portfolios that obtain the highest returns for investors are not usually widely diversified, he said.
“We would also highlight the views of Warren Buffett on the topic: investors who possess a deep level of knowledge may be better off concentrating their investments in areas they understand deeply, rather than spreading their capital too thin,” he added.
On the other hand, Fahad Hassan of Albemarle St Partners advocates a more cautious approach.
He makes sure to discuss position sizing as an important factor when choosing to buy into a new fund, as it helps to understand the manager’s understanding of risk and reward.
“Conviction based position sizing is fraught with behavioural biases and specific guardrails should be in place against excess risk taking,” he told Asset Allocator, and said he sets more stringent requirements for Albemarle portfolios than UCITS.
