Stock pickers are shunning the cardinal rule of investing as they fight the machines trying to replace them - and they're still losing
- Active fund managers are moving away from the time-honored strategy of portfolio diversification as passive investing threatens their sector.
- Active US funds holding fewer than 35 stocks have nearly doubled in the last decade, the Wall Street Journal reported, citing Morningstar Direct data.
- The shift arrives as exchange-traded funds and robo-advisers offer investors diversified portfolios with little to no fees.
- The concentrated portfolios haven't proved their superiority over the last decade, underperforming the S&P 500 during market surges and tumbles, according to WSJ.
- Visit the Business Insider homepage for more stories.
Active fund managers are bucking diversification and opting for concentrated stock picks as passive investing grows in popularity.
Their behavior goes against one of the cardinal rules of investing, which suggests that you can mitigate risk and build a stable portfolio by broadly spreading your wagers. But their hand is being forced by the rise of comparatively inexpensive exchange-traded funds and robo-advisers.
Active US funds holding fewer than 35 stocks have almost doubled in the last decade and their managed assets have nearly tripled, the Wall Street Journal reported Monday, citing Morningstar Direct data.
It's a strategy that trades stability for volatility - and it hasn't exactly worked as intended. WSJ finds that the concentrated funds have still underperformed the S&P 500 and their diversified rivals since the ongoing equity bull market commenced in 2009.
Less diversified funds holding 20 stocks or fewer lagged even more, rising an average 133 percentage points less than the S&P 500 over the same period.
The concentrated portfolios also underperformed during the last economic downturn. Active funds with 35 stocks or fewer fell about 2 percentage points less than the average active fund, but fell behind the S&P 500 by about 0.7 percentage points, according to WSJ.
Concentrated funds never seem to win
Recent market tumbles in 2011, 2015, and 2018 saw mixed results between concentrated and diversified active funds, but the condensed funds never outperformed the broad market during the sell-offs. The market contractions showed stock quantity is less important for active funds, Polen Capital portfolio manager Dan Davidowitz told WSJ.
"In the financial crisis you pretty quickly saw that it didn't matter how many companies you owned, it really mattered how high-quality they were," Davidowitz told them. The Polen Growth fund holds stakes in Facebook, Alphabet and Microsoft, and has outperformed the S&P 500 since its creation, WSJ reported.
Major firms are also showing new interest in portfolio concentration. UBS's asset management branch now holds a low-double-digit percentage of its active equity cash in concentrated funds, up from nearly zero in 2009, according to WSJ. Investors feel that a concentrated portfolio can bring the same low-risk benefits of a diversified fund if the stocks included are curated, high-quality firms, UBS Asset Management head of equities Barry Gill told WSJ.
"I believe it's inevitable that if you fast forward 10 or 15 years, the bulk of surviving active strategies in developed markets will be high-concentration portfolios," Gill said.
Now read more markets coverage from Markets Insider and Business Insider: