High-conviction managers tend to attract headlines when things go wrong rather than when their concentrated style yields impressive off-benchmark returns.
The big hit suffered by portfolio manager Bruce Berkowitz following a recent court ruling over Fannie Mae and Freddie Mac profits served as the most recent warning of the perils of a high-conviction investment approach.
Berkowitz’s flagship $2.7 billion Fairholme fund fell 13% in just one day after the ruling as Fannie Mae stock lost a third of its value and Freddie Mac fell even further.
Berkowitz had bet big on the government-sponsored enterprises, investing 27% of his Fairholme fund in the stocks. He was almost as aggressive with his smaller Fairholme Allocation and Focused Income funds, investing 26.6% and 18.7% respectively. Those funds fell 8.6% and 6.2% on the day of the ruling.
Berkowitz was among a number of investors who had brought a legal challenge to the amended terms of the Fannie Mae and Freddie Mac bailouts, under which the firms pay all of their profits to the government as dividends.
Hopes that the challenge could succeed, and optimism over the Trump administration’s stance, had sparked a big rally in the two stocks – and Berkowitz’s funds – that was quickly reversed after a federal court barred most of the claims.
‘Make no mistake – this is far from over,’ Berkowitz told Barrons after the defeat. But investors who have suffered the rollercoaster ride of the past four months may not be quite as bullish.
Some were quick to draw parallels with the collapse of Valeant and its role in the Sequoia fund’s fall from grace.
The $4.2 billion fund once housed a 30% stak e in the pharmaceuticals group, leading to heavy losses when its fortunes turned. Sequoia finally dumped the stock last summer, but not before the shares had fallen more than 90% from their peak.
The fallout led to the resignation of manager Bob Goldfarb as the fund endured its worst run of poor performance since 1990 and was hit by heavy redemptions. New manager David Poppe has pledged not to hold more than 20% of the fund in a single stock from now on.
ENDEAVOUR TO SUCCEED
All of which may have cooled fund buyers’ enthusiasm for high-octane, strong-conviction approaches.
But the returns on offer from managers who get it right more often than not from their big bets can be substantial.
Take the $2.8 billion Parnassus Endeavor fund, the best-performing mainstream US equity fund over the past 10 years, returning 229%, well ahead of any other fund in the Multi-Cap Core sector. Citywire + rated manager Jerome L. Dodson, who we profiled here, currently holds just 25 stocks in the fund.
The Endeavor fund is remarkable not only for the returns it has delivered but the consistency with which it has delivered them. The fund is in the top decile of the sector over one year, top of the tree over three and second over five.
The $2.3 billion Transamerica Large Cap Value fund may not have been around long enough to match Parnassus Endeavor’s record, having launched in 2010, but since taking over the fund in 2012, Citywire AA-rated managers John A. Levin and Jack Murphy, of Levin Capital Strategies, have offered up further proof of the power of a concentrated approach. Currently holding just 36 stocks, they have delivered 106.9% over five years, second only to the Dodge & Cox Stock fund in the Large-Cap Value sector.
For others, returns have been more volatile. The tiny $52.4 million Berkshire Focus fund boasts long-term returns that belie its size, up 214% over the past 10 years and topping the Multi-Cap Growth sector. But manager Malcolm Fobes, who currently holds just 27 stocks in the fund, has endured a more fallow period of late, with the fund up just 6.8% over the past three years.
Meanwhile, the Miller Opportunity Trust, formerly the Legg Mason Opportunity fund and housing just 36 stocks, is top of the Multi-Cap Core sector over five years, with a 126.3% return.
But that headline figure hides significant underperformance in 2011 and the first half of last year. Stretch the period under review to 10 years, however, and the fund serves up another reminder of the potential downsides of a concentrated approach: up just 20.9% over a decade as manager Bill Miller suffered a 65% loss over 2008 as the financial crisis hit.
Both the Miller Opportunity and Berkshire Focus fund also stand out as high-conviction funds on another measure.
We ranked funds in the US large- and multi-cap equity sectors according to the link between their performance and that of the S&P 500. Funds with a low ‘r-squared’ score have a low correlation with the index, while those with a high score are heavily influenced by the S&P 500’s movements.
Over one, three and five years, the Sequoia fund tops the list as the least correlated to the wider market. The Valeant position accounts for much of that, although even with its disposal and the reforms to its investment approach, the fund remains concentrated, with just 26 stocks held alongside one corporate bond and treasuries.
Over five years, the Fairholme fund is the fifth least correlated, with Berkshire Focus sixth and the Miller Opportunity Trust sitting just outside the top 20 of the 1,149 funds we examined.
Even with its heavy outflows following the Valeant debacle, the Sequoia fund remains the largest within the 20 most ‘active’ funds at $4.2 billion, followed by the $2.9 billion Janus Contrarian fund run by Dan Kozlowski, which features just 35 stocks and boasts a sizeable 9.6% weighting in its top holding United Continental Holdings.
Fidelity’s Advisor Equity Growth fund, meanwhile, ranks just below Fairholme for size, and although the $2.7 billion portfolio boasts a relatively large number of stocks at 154, manager Jason Weiner is unafraid of placing big bets on his favorites, with 9.8% held in Facebook and 6.3% in Google’s parent Alphabet.
Our ranking also shines a light on some much smaller, obscure and in some cases very esoteric portfolios.
Take the American Growth Fund Series Two portfolio, accounting for just $1.7 million at the time of its last annual report, having failed to gain scale over its six-year lifetime.
The fund dramatically changed tack last year, switching from a mainstream US equity fund to one focused on the legal cannabis business.
But investors don’t appear to share manager Timothy Taggart’s enthusiasm for marijuana stocks, with estimates from Lipper suggesting they have pulled $460,000 from the fund since the change was announced, leaving the portfolio at just $600,000.
Fund manager charges have proved a major obstacle to the fund’s returns given its small scale, with the portfolio sitting right at the bottom of the Multi-Cap Growth sector over five years with just a 12.3% return.
Another extraordinary story can be found in the shape of the Copley fund, second only to Sequoia and American Growth Fund Series Two in the active stance of its manager, Citywire AA-rated Irving Levine.
Levine is 95 years old and has run the $83 million fund since 1978. He reached AA status at the end of last year, after a stellar 12-month run that resulted in the Copley fund being placed top in the Wall Street Journal’s Winners’ Circle contest.
Levine runs a concentrated portfolio of just 34 stocks and hardly ever trades. This had led to a big build-up in the unrealized gains in the portfolio, prompting the Securities and Exchange Commission to set aside a provision to cover the potential tax impact in 2007. Levine complied but labelled the ruling ‘dead wrong’ in a court battle with the regulator he eventually lost.
Upright Growth is another small fund to have enjoyed a recent spot in the limelight, with strong patches of performance noticed by The New York Times and Reuters. A laggard over 10 years and mid-ranking over five, the $12 million portfolio is a volatile performer that can shoot up 15.6% in a single month, as it did in February.
Keeping more than a third of the fund in cash at the time of the fund’s last annual report and warning of overvalued stocks, that caution hasn’t prevented manager David Chiueh from holding more than a fifth of the portfolio in a single company, semiconductor maker Himax Technologies. The stock’s 51% surge since the beginning of last month, after a 41% slump in the previous six, explains much of the fund’s volatility.
If nothing else, our review of portfolio managers unafraid to take big bets shows a wide variety of approaches. And those scared off these funds by some high-profile losses could be passing over some of the best fund managers in the land.
20 most 'active' large- and multi-cap funds
|Fund||Size ($M)||5-year r-squared-score||5-year total return (%)|
|American Growth Fund Series Two||0.6||0.24||44.1|
|Symons Value Institutional||86.3||0.47||90.3|
|Monteagle Informed Investor Growth||11.2||0.48||91|
|Morgan Stanley Inst Mid Cap Growth Portfolio||630.2||0.5||54.1|
|Ridgeworth Innovative Growth Stock||28.6||0.54||130.2|
|Morgan Stanley Multi Cap Growth Trust||331.2||0.56||122.3|
|Transamerica Capital Growth||669.9||0.57||146.1|
|Transamerica Multi-Cap Growth||289.1||0.58||50|
|Fidelity Advisor Equity Growth||2698.4||0.59||135|
|Dunham Focused Large Cap Growth||71.8||0.6||104|
|Schwartz Value Focused||21.3||0.61||53.4|
|Principal MidCap Growth||143.3||0.61||123|
Source: Lipper. Data to the end of February 2017.