Investment circles typically fall within two camps of equally vehement supporters: those who advocate for concentrated investing and those who advocate for diversified investing. In the simplest terms, the two investment types are characterized by portfolio size, with concentrated portfolios typically containing fewer than 30 holdings whereas diversified portfolios often contain hundreds. While both methods can find a place in any investment strategy, we believe concentrated investing is typically the less traditional, and therefore more controversial, method. We’re here to make the case for concentrated investing.
Benefit #1: Matched Volatility
Comparing concentrated investing to diversified investing is a bit of a misnomer because concentrated investment portfolios often are, and have to be, diversified. One of the biggest fallacies that pits large “diversified” portfolios against concentrated portfolios is their perceived levels of risk, or volatility. But in fact, the Law of Diminishing Returns has been applied to this very concept1, finding that concentrated portfolios of 20 to 25 stocks are exposed to the same level of volatility as portfolios of 100 or more stocks. Another study2 found that when investors were asked to create funds made up of their top 25 preferred stocks, they had roughly the same level of volatility as their diversified index funds. In fact, concentrated portfolios of the top 30 preferred stocks were actually found to be less volatile than their diversified index funds, proving that larger portfolios are not always safer.
Benefit #2: Potential for Outperformance
Depending on an investor’s goals, we believe the greatest case for concentrated investing lies in its potential to outperform the market and its diversified benchmark indices. Even for funds with as few as 5 holdings, the more concentrated a portfolio, the higher its total returns can be. The same aforementioned study2 that found comparable volatility also found that when investors formed portfolios of their top five preferred stocks, those funds produced 10.77% total return compared to a total return of just 5.05% for its highly diversified benchmark index fund. Concentrated portfolios of the top 30 preferred stocks still outperformed their diversified indices by an average of 1.97%2.
Benefit 3: Informed Decision-Making
Investors with hundreds of holdings in their portfolio cannot possibly know enough about each company to make an educated guess regarding its growth potential or vulnerability to specific shocks. We believe managers with concentrated portfolios are better equipped to respond to geopolitical events, significant legislative reforms, or natural disasters that might impact each individual holding one way or another. The intrinsic value3 of each company can be taken into account, which is essential for evaluating forward-looking, long-term growth to help them cut through the noise of short-term stock valuations or the seduction of trending stocks. Being able to conduct in-depth fundamental research into each company in a concentrated portfolio is the best way to optimize diversification as the key to mitigating real risk and realizing capital appreciation. We believe it’s this level of understanding that makes concentrated investing superior to its diversified counterpart.
The TrueShares Low Volatility Equity Income ETF (DIVZ) seeks to outperform the market through an actively managed, concentrated portfolio of 25 to 35 favorably valued companies with attractive dividends that the portfolio managers expect to grow over time. This dividend portfolio with high active share has historically had lower volatility than the overall market, which we’ve established is possible with as few as 20 to 25 stocks. DIVZ focuses on companies with market capitalizations of $8 billion or greater while also being highly diversified across industries, including healthcare, telecom, retail, defense, finance, energy, biotech, service, and security.
1 – https://intrinsicinvesting.com/2016/12/01/excessive-diversification-is-pointless-damages-returns/
3 – https://www.cannonfinancial.com/uploads/main/9725_insights-on-how-to-manage-a-concentrated-portfolio.pdf
TrueShares Low Volatility Equity Income ETF is also subject to the following risk: As an ETF, the Fund is exposed to the additional risks, including: (1) concentration risk associated with Authorized Participants, market makers, and liquidity providers; (2) costs risks associated with the frequent buying or selling of Fund shares; (3) market prices may differ than the Fund’s net asset value; and (4) liquidity risk due to a potential lack of trading volume. Dividend Paying Security Risk. Securities that pay high dividends as a group can fall out of favor with the market, causing these companies to underperform companies that do not pay high dividends. Dividends may also be reduced or discontinued. Equity Market Risk. Common stocks are susceptible to general stock market fluctuations and to volatile increases and decreases in value as market confidence in and perceptions of their issuers change based on various and unpredictable factors including but not limited to: expectations regarding government, economic, monetary and fiscal policies; inflation and interest rates; economic expansion or contraction; and global or regional political, economic and banking crises. Market Capitalization Risk. The Fund may invest is securities across all market cap ranges. The securities of large-capitalization companies may be relatively mature compared to smaller companies and therefore subject to slower growth during times of economic expansion and may also be unable to respond quickly to new competitive challenges, such as changes in technology and consumer tastes. The securities of mid-capitalization companies may be more vulnerable to adverse issuer, market, political, or economic developments than securities of large-capitalization companies and generally trade in lower volumes and are subject to greater and more unpredictable price changes than large capitalization stocks. The securities of small-capitalization companies may be more vulnerable to adverse issuer, market, political, or economic developments than securities of large- or mid-capitalization companies and generally trade in lower volumes and are subject to greater and more unpredictable price changes than large- or mid-capitalization stocks. Depositary Receipts Risk. American Depositary Receipts (“ADRs”) have risks similar to those of foreign securities (political and economic conditions, changes in the exchange rates, etc.) and entitle the holder to all dividends and capital gains that are paid out on the underlying foreign shares.