When stock market leadership narrows and just a handful of issues determine how an index performs, mutual funds that hold a small number of positions are worth a closer look.
Such an environment can provide an opportunity for these focused funds to excel — or to struggle. Managers of a typical stock fund can take hundreds of positions in an effort to outperform their peers, while not straying far from them because they seem to own a little of everything. Focused funds hold a concentrated collection of their managers’ best ideas.
Taking those big bets will cause focused funds to deviate more from the returns of other funds with the same objectives, raising the odds of outperforming or underperforming. There may be little at stake from that strategy early in a bull market when everything is going up or, for that matter, in a bear market when everything is going down. In a less robust market like this one, however, the consequences of the managers’ decisions are amplified.
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A good illustration of this can be found in the eight large-capitalization value funds in investment researcher Morningstar’s database that have three-year track records, 50 stocks or fewer in their portfolios, and “focus” or “concentrated” in their names. Three of the five had returns in the top 5% of large-cap value funds in the three years through March 22. Two ranked in the bottom 10%, leaving three in the middle 85%.
Those three strong funds are SunAmerica Focused Dividend Strategy FDSAX, -0.18% , Touchstone Focused TFFYX, +0.30% and Hillman Focused Advantage HCMAX, -0.23% Their annualized three-year returns ranged between 11.6% and 13.1%.
The first two funds earned Morningstar’s highest ranking of five stars. The Hillman portfolio rates three stars, perhaps because of its hefty annual expenses of 1.5%, no doubt an artifact of its small asset base of about $35 million. The other two funds each have more than $1 billion in assets.
Three focused large-cap growth funds out of 20 have three-year returns in the top quintile for that group: AllianzGlobal Focused Growth PGWCX, -0.07% , Deutsche Large Cap Focus Growth SCQGX, +0.11% and Eaton Vance Focused Growth Opportunities EAFGX, +0.00% . The first two rate four stars, the Eaton Vance portfolio gets three.
Among large-cap blend funds, which hold a mix of value and growth stocks, Lazard U.S. Equity Concentrated LEVOX, -0.07% is the standout by far and the only focus fund in this category to rate five stars.
Focused funds exist for other size categories, but only midcap growth has more than two portfolios. Three of the six midcap growth funds are in the top 10% for that category: Akre Focus AKRIX, +0.47% , Delaware Pooled Focus Smid-Cap Growth DCGTX, +0.40% and Hennessey Focus HFCSX, +0.68% . All are five-star funds.
Value stocks have underperformed growth stocks for several years but have shown signs of making a comeback lately. That could make one of the better concentrated large-cap value funds a sensible portfolio addition.
The same could go for the midcap funds. Larger companies tend to outperform in narrow markets. If the broad market gets a second wind, then stock-picking should matter less but small- and medium-sized companies should play catch-up. If it doesn’t, then owners of the midcap focused funds may be rewarded by the strong selections that their managers have a history of making.