Concentrated mutual funds pullling in assets, not returns

NEW YORK, May 22 (Reuters) - Investors have been flocking to highly concentrated stock mutual funds in the hope that more daring bets will produce bigger returns, but it hasn’t worked out that way.

So-called concentrated mutual funds - those that hold fewer than 30 stocks and are by nature risky - are growing far faster than other types of actively managed funds. But some 80 percent of these funds are posting performances that put them in the bottom half of their peers, according to data from S&P CapitalIQ.

Over the five years to December 2013, the assets invested in concentrated funds jumped from $44.5 billion to approximately $117 billion, according to data from fund tracker Morningstar, a growth rate 67 percent greater than actively managed funds as a whole.

The move to riskier funds may come, ironically, as a side effect of the growing popularity of passive index funds that only track market benchmarks. As indexing becomes mainstream, investors who choose to add any active funds to their portfolios are increasingly opting for those that offer the greatest chance of outperformance, even it comes with more risk.

The aging bull market and record-high stock prices, meanwhile, have convinced some financial advisers that they need to be more strategic and less sweeping in their bets.

“In order to beat the market you have to do something that ETFs don’t, which is using specialized knowledge to know which areas or stocks to overweight,” said Jeff Tjornehoj, head of Lipper research in the U.S. and Canada.


Concentrated funds tend to be put out by smaller firms in the hope that strong performance will lead to asset growth.

That worked especially well for performance outlier the Matthew 25 Fund, which has seen its assets grow almost 4,000 percent in just over five years with average annual returns of 29.9 percent.

It dwindled to as low as $22 million in assets under management during the 2008 financial crisis. Since then, portfolio manager and firm founder Mark Mulholland has seen his portfolio, heavy in positions in Apple, outdoors retailer Cabela’s, and snowmobile maker Polaris Industries, put him in the top 1 percent of the 1,305 large-cap growth funds tracked by Morningstar. The fund now holds $828 million in assets.

“The only reason you diversify is to reduce risk and the only reason you concentrate is to increase return,” he said.

He has approximately 13 percent of his portfolio in Apple, his top position, because he expects the company to continue to be a major player in the shift from PCs to handheld devices like iPhones and tablets and remains one of the cheapest stocks in his portfolio by instrinic value, he said.

Even funds that have not posted such outsized returns have been pulling in investor dollars. The largest concentrated fund, the FMI Large Cap fund, saw its assets rise from approximately $1.5 billion under management at the end of 2008 to $8.7 billion today, even while posting returns that fell in the bottom half of all large cap funds, said Todd Rosenbluth, director of fund research at S&P CapitalIQ.

Advisers who have moved more money into concentrated funds say they were hesitant to invest in the broad market now that the rally has made it harder to find compelling values.

“The managers we like have flexibility and if they aren’t finding opportunities they can be out there in cash,” said Curtis Holden, a senior investment officer at Tanglewood Wealth Management, a Houston firm that oversees approximately $800 million in client assets.

“We’ve shifted a little more away from index funds not because we don’t believe that they’re efficient but because we’re getting a little more cautious after the run-up the market’s had,” he said. (Editing by Linda Stern; Editing by Chizu Nomiyama)