Many financial advisors espouse the virtues of diversification in investments in order to minimize risk while also growing assets, but that belief is coming under increasing criticism.
Actively managed funds with hundreds of stocks are seen as “closet index” funds that charge much bigger fees than index funds. They’re also criticized for diversification that dilutes potential gains. That’s why some managers prefer concentrated portfolios, which are less diversified but reflect their “best ideas.”
Bill Nygren, the legendary portfolio manager of several Oakmark funds, wrote in his latest market commentary that “any benefit from reducing risk by adding more stocks to our portfolio is outweighed by the return lost from diluting our best ideas. We are trying to maximize our probability of outperforming by a meaningful amount…. That’s why our funds range from a low of 20 stocks to a high of about 60.” He’s not concerned with diversification because Oakmark investors “are already taking steps to diversify their assets.”
Andrew Mehalko, chief investment officer of AM Global Family Investment Office, says that even “thirty names is still over-diversified.” He says that “ten high-performing” companies” can mean less risk for investors than 30 stocks because all stocks have market risk.
Managers are “confusing diversification with risk management,” says Mehalko. He suggests that in addition to concentrating their portfolios to increase the potential to outperform, investors also diversify their risks for stocks, currencies, interest rates, liquidity, inflation, leverage and managers.
Most actively managed mutual funds don’t beat the stock market consistently. An S&P/Dow Jones study, reported recently by The New York Times, found that hardly any funds in the top 25% for the 12 months following the market trough in March 2009 placed in the top quarter for the next four rolling 12-month periods. Last year only 10% of equity mutual funds outperformed the S&P 500.