Confidence and concentrated funds

10Jan06

Concentrated mutual funds are characterized by their holding a smaller number of stocks in their portfolios. By holding a couple dozen stocks versus the hundred(s) held by more diversified competition, the funds are often more volatile and more dependent on their fund managers’ skills.

Timothy Middleton at MSN Money notes that financial advisors who utilize these funds are not necessarily in it for the long haul. Generally they are opportunistic in their use of these funds. For whatever reason a number of high profile concentrated mutual funds have had relatively poor performance in the past year. Does this equal a buying opportunity?

Middleton notes that trying to time your investments in these funds is dicey.

The hazard of trading focused funds, rather than owning them continuously, is that you’ll misjudge when to buy and sell them. Academic research has shown that even professional investors are poor market timers, implying that amateurs have even less chance of success.

It seems that an investment in a focused fund is really dependent on one’s confidence in a manager’s skill. Even the best performing managers do not necessarily outperform the market every year. Bill Miller is more the exception than the rule.

“The lesson you draw from this is to stick with it,? says John D. Spears, a managing director. In order to do so, however, he admits: “You have to have some conviction about the process — about the theory the manager is practicing. If you’re just looking at year-by-year results to gauge future outcomes, you’re going to give up.?

Chet Currier at Bloomberg.com brings the risk of focused fund investing home in a profile of the Jensen Portfolio (JENSX). The once hot fund is now dealing with a multi-year slump.

A focus on some of the market’s largest companies has not served the fund well. However the fund’s managers remain steadfast in their investment process.

“True investing is making a commitment to own a company, to participate in its business over the long term and not betting on short-term movements in its stock price,” Millen wrote. “To change our core discipline would dilute our efforts and all that we believe in.’

If management has not changed their approach, should an investor stick with a fund through a down period? Currier is planning on sticking with the fund, due in part to the manager’s steadfastness.

Every active investment process is going to go through down periods. The challenge for investors is whether to stick with it through the down period. Clearly the first question an investor needs to ask is whether the manager has changed their investment process in some substantial way. Absent that, it comes down to a question of confidence.

Confidence should not come from blind faith. Confidence in any investment process comes from thorough research and a full understanding of the risks involved. As always research is important for investors, even those who focus on mutual funds.




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