A growing number of fund managers have developed “concentrated” or “high-conviction” equity portfolios in a bid to differentiate themselves from the large number of “benchmark aware” funds that charge relatively high fees but do not outperform low-cost index funds and ETFs. However, Morningstar has found there isn’t a strong relationship between the degree of concentration and positive excess returns.
“When looking at global equities, a more concentrated portfolio does not necessarily lead to better excess returns,” Morningstar says in its latest global equity funds review.
“Champions of a concentrated approach argue that a high-conviction style is required to beat the benchmark. We think the argument is more nuanced.”
According to Morningstar, in the domestic equity market, being meaningfully different from the S&P/ASX 200 can be tricky. The five largest stocks account for 30 per cent of the index.
By contrast, the five largest stocks in the MSCI World Index add up to around 7 per cent of the index. The more diversified global market makes it easier for managers to differentiate themselves from the index without having to be overly concentrated. Morningstar defines a global equity portfolio with 20 to 40 stocks as concentrated.
Even global portfolio managers with 100 stocks can look very different from the benchmark, it says
Capital Group New Perspective, which has a Morningstar ‘gold’ rating, has 250 stocks and has an active share of 70 per cent (that is, 70 per cent of the fund is different from the index). MFS Global Equity (also rated ‘gold’) has 90 stocks and an active share of 90 per cent.
The review says: “From our analysis of large cap global equity managers, there isn’t a strong relationship between the degree of concentration and positive excess returns.
“Portfolios with fewer than 50 stocks have more dispersed excess returns but the majority of those are negative. There is no strong link between concentration and outperformance in global equity funds.
“Individual stock missteps are an inevitable outcome and are amplified in a concentrated portfolio. When a portfolio manager loses their Midas touch, being diversified can soften the blow. Some of our favourite strategies have been able to differentiate themselves from the benchmark, and to good effect, with more than 100 stocks in the portfolio.”
It finds that the majority of active managers have underperformed the index over the past 10 years. However, a positive is that active managers are less correlated to down markets, compared with up markets.
Morningstar has made a number of changes to its ratings in the review. It upgraded Franklin Global Growth, MFS Concentrated Global Equity and MFS Global Equity – all from silver to gold.
Commenting on Franklin Global Growth, Morningstar says: “What sets the strategy apart is thoughtful portfolio construction that aims to blend uncorrelated earnings streams to diversify economic exposure.”
It says the MFS funds are particularly good value for money. They have a repetable process that focuses on high quality companies with sustainable long-term earnings growth.
It has upgraded Dimensional Global Core Equity Trust, Dimensional Global Large Company Trust, Dimensional Global Small Company Trust, Lazard Global Small Cap and Vanguard International Small Companies – all from bronze to silver.
It initiated coverage of a number of funds: Capital Group New Perspectives with a gold rating; Magellan Global Trust and Magellan High Conviction, both with silver ratings; Platinum International and Platinum Capital, both with silver ratings.
It downgraded Aberdeen International Equity from silver to bronze, based on concerns about the consistency of its investment process. It downgraded Zurich Investments Global Thematic Share to bronze, due to “thematic missteps” and it downgraded iShares MSCI Japan ETF to neutral due to its “limited investment universe and heavy bias to certain sectors and larger market cap stocks.”
It ceased coverage of Threadneedle Global Equity Income Hedged, Harding Loevner Emerging Markets and CFS wholesale Global Resources because they “failed to meet our criteria for ongoing research.”
Funds with existing gold ratings include iShares S&P 500 AUD Hedged ETF, iShares S&P 500 ETF, Magellan Global, Platinum International Fund, Vanguard US Total market Shares ETF, Capital Group New World,