Prediction: Rise of Concentrated Funds

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TheTimeLord
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Prediction: Rise of Concentrated Funds

Post by TheTimeLord »

I am not saying you should buy one or it is a good thing but I think within 5 years we will see a rise and return of the concentrated actively managed fund holding 20-30 stocks. Some will have great results other very mediocre. But those with great results will draw people until they become too large for the number of issues they hold. I believe this will be indirect response to the massive inflows occuring in index funds. The closet indexers will start to shrivel and die. Think Janus Twenty or Oakmark 30.
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Re: Prediction: Rise of Concentrated Funds

Post by Tigermoose »

I'll stick with the $&P 500.
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Re: Prediction: Rise of Concentrated Funds

Post by nisiprius »

I would be more interested in hearing your reasons for this prediction than in the prediction itself.
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Austintatious
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Re: Prediction: Rise of Concentrated Funds

Post by Austintatious »

I'm wondering if the Motif experiment is an example, if only "sort of", of what you have in mind.

https://www.motifinvesting.com/?utm_exp ... gle.com%2F

I was intrigued by the concept, when I first read of it, though not so intrigued that I've invested in it. I'd guessed that the idea would appeal to younger investors, but I have no idea how successful they've been. I, too, am curious as to why, now, you think the idea is about to take off.
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Re: Prediction: Rise of Concentrated Funds

Post by Beliavsky »

nisiprius wrote:I would be more interested in hearing your reasons for this prediction than in the prediction itself.
If a good manager has differential insight into only 20-30 stocks, it make sense for him to own only those, and for the
investor to have most of his money in passive funds and a fraction in the concentrated fund.

Concentrated funds may have lower Sharpe ratios than diversified ones because they are more volatile, but I wonder if they
are a better complement to passive funds than actively managed diversified funds. They should be evaluated in a portfolio
context.
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Re: Prediction: Rise of Concentrated Funds

Post by LongerPrimer »

When Louis Ruykeser was on PBS, his show always featured small successful MF (of course). He also had JB on his show saying that small MF can beat index funds fairly easily (also collapse faster ).

Personally, I m winding down activity and don't really care. :annoyed
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Re: Prediction: Rise of Concentrated Funds

Post by Tanelorn »

Beliavsky wrote:Concentrated funds may have lower Sharpe ratios than diversified ones because they are more volatile...
They might have lower expected Sharpe ratios, assuming an average stock market return (no skill) and higher volatility due to lower diversification. But it's almost certain that some will have much higher realized Sharpe ratios because it's much easier to get lucky and outperform the indices by a meaningful amount if you have only 25 stocks instead of 250.

I think the reason behind OP's thinking is that mutual funds are having a harder time adding value as the market gets more efficient, and hence proposing lots of risky strategies will be a marketing success since almost certainly some risky strategies will pay off and raise lots of money.
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Re: Prediction: Rise of Concentrated Funds

Post by FrugalFrida »

There was one global stock fund started here last year. They invest in 100-150 large value stocks with a "expected stable risk-adjusted return" and have a preference for stocks with high dividends. Diversification in sectors and regions.

This fund new but so far it adds 3% over the global index fund.
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Re: Prediction: Rise of Concentrated Funds

Post by jaab »

I think OP has already given a good reason for his expectation: less concentrated funds are basically overpriced factor beta portfolios ("closet indexers"). Be it risk factors or mispricing factors. And this kind of portfolio you can buy for cheap as ETF or fund nowadays.
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Re: Prediction: Rise of Concentrated Funds

Post by nisiprius »

There was a lot of interest a few years ago in "active share."

https://www.fidelity.com/bin-public/060 ... -share.pdf
Although often-cited research has suggested that active share is positively correlated with excess return, this article argues that higher levels of active share come with greater levels of return dispersion, and higher downside risks, as well. Most striking, however, may be that our analysis suggests that for large-cap managers in the 15-year period observed, the relationship between higher levels of active share and excess return appears to have been primarily driven by smaller-cap portfolio exposures.
Is Your Fund Manager Active Enough? A measure called "active share" tries to differentiate active managers from closet indexers.
Cremers and Petajisto teamed up to find how to differentiate true stockpickers from closet indexers. They finished the first draft of their research in 2006 and in 2009 published a paper, "How Active Is Your Fund Manager? A New Measure That Predicts Performance." That measure -- which they named "active share" -- is the percentage of a fund's weight-adjusted portfolio that differs from its benchmark.... Unfortunately, there is no real evidence that active share is a predictor of returns," says Larry Swedroe, co-founder and director of research of BAM Advisor Services....
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Re: Prediction: Rise of Concentrated Funds

Post by TheTimeLord »

nisiprius wrote:I would be more interested in hearing your reasons for this prediction than in the prediction itself.
The gospel of indexing is spreading and spreading very rapidly. Most mutual funds are closet indexes whether they know it or not and will always under perform because of their expenses and fund flows. The only hope of outperformance is concentrated positions which in a mutual fund limits you to about 30 holdings. That is the thumbnail sketch.
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Re: Prediction: Rise of Concentrated Funds

Post by daffyd »

There is an interesting (but conflicted) post here on combining a cap-weighted index with a concentrated fund instead of a single fund with a milder tilt:
http://www.alphaarchitect.com/blog/2014 ... you-think/

It is imperfect (e.g. focusing on the top 500 when the Value factor based on the lowest 1/3rd Price-to-Book hasn't been rewarded in the US for Large Caps recently and the analysis ignores the cost of turnover) but makes me think about the Australian situation.

Here the process has begun this year with a number of concentrated fund launches, for example focusing on excluding the top 20 ASX stocks (around 65-70% of the ASX300). Sadly there is competitive space for them around the 0.8-1.0% p.a. fee level: while Vanguard has a great ASX300 ETF for 0.15% p.a. our large cap indices are very concentrated and our small cap indices perform poorly (consistently beaten by active funds even after fees). There is no passive small cap value fund (even from DFA) with the closest thing being a fundamental index small cap fund from around 0.86% p.a. With home bias (for both rational and less rational reasons) there is a growing demand for and a growing supply of Australian non-closet-index funds. My hope is that someone will do a fundamental index small or mid-cap ETF at lower fees but I suspect they'll still be able to charge 50 or 60bps for one.
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Re: Prediction: Rise of Concentrated Funds

Post by packer16 »

I agree and what I think is really needed are funds that appear when opportunities exists and return capital when they do not. By opportunities I mean things that are at least 50 cent dollars. This would allow the investor to focus non indexed portions of his portfolio on truly mispriced segments of the market.

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Re: Prediction: Rise of Concentrated Funds

Post by mjb »

I have no issues with a low turnover basket of companies. Look at Wellington. What is really important is patience, time in market, etc. I know a few guys that watch about 30 stocks closely, and buy when one's share price drops due to a bad quarter. I started doing this before I found out about Bogleheads.

Frankly, the strategy can work out really well if you spend a lot of time watching the market and it takes a lot of discipline to not sell at the wrong times. The people I know consistently match or beat the market and have lower volatility, but the amount of time they spend eats up a large part of the gain. That is why I now primarily index and use a few, select, low turnover funds as satellite holdings.
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Re: Prediction: Rise of Concentrated Funds

Post by pkcrafter »

StarbuxInvestor wrote:I am not saying you should buy one or it is a good thing but I think within 5 years we will see a rise and return of the concentrated actively managed fund holding 20-30 stocks. Some will have great results other very mediocre. But those with great results will draw people until they become too large for the number of issues they hold. I believe this will be indirect response to the massive inflows occuring in index funds. The closet indexers will start to shrivel and die. Think Janus Twenty or Oakmark 30.
Like Nisiprius, I'm also wondering why you predict this. Cremers and Petijisto have concluded that high active share coupled with concentration produces the best performing funds. Fine, but for the most part investors can't handle them. Look at Fairholm, a high active share and concentrated..

fund return, 10 year - 10.08%
Investor return -- 5.22%

Concentrated funds with high active share are on and off, which leads to buy high, sell low. They attract dumb money when they are hot. And when they're not...investors bail. Oddly, investors who take this kind of risk can't seem to tolerate underperformance from their high-flying funds. They figure they are taking high risk and there should be a payoff.

As for the massive (recent) inflows of cash into index funds, they are experiencing the same thing. This is just what happened in the late 90s.

I tried to provide a warning for new indexers in this blog entry.

http://blbarnitz4.wordpress.com/2014/09 ... -indexers/

Oh, I predict the next hot area...after MO gets tired, will be active funds advertising low volatility and limited downside.

Paul
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Re: Prediction: Rise of Concentrated Funds

Post by nedsaid »

I remember that the concentrated funds were all the rage in the 1990's, the idea being that a good stock picker is only going to have so many good ideas. I don't think this idea has gone away, these type of funds still exist. The public can put its attention only on a limited number of ideas so you don't hear much about these now but true believers in this concept are still out there.

It is the same idea of polling to predict how voters will vote. The larger the sample size (assuming you aren't cherry picking what you are sampling, that the sample is random) the better that the sample would represent the population as a whole. It makes sense that the more stocks you add to a portfolio, the more that it would tend to mirror the index. As in a poll, the larger sample sizes have less margin for error.

My suspicion is that most portfolio huggers are not doing this on purpose, they are picking enough stocks to reduce the single stock risk and will conscientiously diversify across industry sectors. The more diversified they are by adding to the number of stocks in the portfolio and the more they are diversified across sectors, the higher odds that their fund will have index-like returns. To outperform, they would have to sector tilt or tilt towards the performance factors that Larry Swedroe talks about. The more factors you invest in, I suspect the higher odds of market performance and the lower odds of outperformance. The very act of diversification increases the odds that your portfolio will act like the index.

Saying that you must be diversified is a way of saying that you want a market portfolio.
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Re: Prediction: Rise of Concentrated Funds

Post by Toons »

Concentrated similar to Janus Twenty:

https://ww3.janus.com/Janus/Retail/Fund ... e?fundID=2
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Re: Prediction: Rise of Concentrated Funds

Post by TheTimeLord »

pkcrafter wrote:
StarbuxInvestor wrote:I am not saying you should buy one or it is a good thing but I think within 5 years we will see a rise and return of the concentrated actively managed fund holding 20-30 stocks. Some will have great results other very mediocre. But those with great results will draw people until they become too large for the number of issues they hold. I believe this will be indirect response to the massive inflows occuring in index funds. The closet indexers will start to shrivel and die. Think Janus Twenty or Oakmark 30.
Like Nisiprius, I'm also wondering why you predict this. Cremers and Petijisto have concluded that high active share coupled with concentration produces the best performing funds. Fine, but for the most part investors can't handle them. Look at Fairholm, a high active share and concentrated..

fund return, 10 year - 10.08%
Investor return -- 5.22%

Concentrated funds with high active share are on and off, which leads to buy high, sell low. They attract dumb money when they are hot. And when they're not...investors bail. Oddly, investors who take this kind of risk can't seem to tolerate underperformance from their high-flying funds. They figure they are taking high risk and there should be a payoff.

As for the massive (recent) inflows of cash into index funds, they are experiencing the same thing. This is just what happened in the late 90s.

I tried to provide a warning for new indexers in this blog entry.

http://blbarnitz4.wordpress.com/2014/09 ... -indexers/

Oh, I predict the next hot area...after MO gets tired, will be active funds advertising low volatility and limited downside.

Paul
I am simply making a prediction of what I believe will happen because of the factors in play. I must admit I am a touch confused why saying the funds will grow in popularity and number is somehow an issue. This is not a recommendation of these types of funds but an observation on the evolution of financial products.
Last edited by TheTimeLord on Sat Oct 25, 2014 10:20 am, edited 1 time in total.
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Re: Prediction: Rise of Concentrated Funds

Post by TheTimeLord »

Toons wrote:Concentrated similar to Janus Twenty:

https://ww3.janus.com/Janus/Retail/Fund ... e?fundID=2
That would be a prime example, Oakmark Select will be another.

http://www.oakmark.com/Our-Funds/Overview/Select.htm
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Re: Prediction: Rise of Concentrated Funds

Post by columbia »

Slightly less concentrated, but Vanguard has that global minimum volatility fund with about 350 holdings.
It will be interesting to see how that fares over the next twenty years....assuming it's still around.
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Re: Prediction: Rise of Concentrated Funds

Post by pkcrafter »

Starbux, nothing wrong predicting, in fact I added my own prediction. Most fund managers don't have the skill or latitude to open a high active share concentrated fund, especially on the back of a market downturn. That's why I think we will see new funds or ETFs which will claim lower risk. Of course, investors won't be happy with them for long unless they outperform. In the end, it won't change anything I'm doing. :sharebeer

Paul
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