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Is how many stocks do you need to own to really be diversified? The number is probably a lot lower than you think. Concentrated portfolios are the opposite of broad market indexes or funds and ETFs. They only own a handful of stocks, typically twenty to thirty names. The goal is to own the best performers without all of the dead weight. I'm Barry Ritolts, and on today's edition of At the Money, we're gonna discuss whether or not you
should own a concentrated portfolio. To help us unpack all of this and what it means for your holdings, let's bring in Andrew Slimmon. He's the managing director at Morgan Stanley Investment Management, where he leads the Applied Equity Advisors team and serves as senior portfolio manager for all of Morgan Stanley's long equity strategies. His team manages about eight
billion dollars in client assets. Slimmon's portfolios have done well against the indexes, and his global portfolio has trounched the benchmarks. Let's start with the basics. What exactly is a concentrated portfolio.
As I think about, a concentrated portfolio means two things. As you said, it can be a limited number of positions, so you know, ten to twenty stocks can be concentrated, or it can mean a limited number of what I
would call directional positions. So if you think about the S and P five hundred has lots of different sectors, you could have a lot of stocks, but say you put them all in one or two sectors, you would you would have a concentrated portfolio simply because it had made a directional positioning versus a more diversified situation.
So what are the advantages of having just a few stocks or just a few sectors. How does that generate better returns than the market.
If you have a limited number of stocks, you're trying to find the best the best stocks in that group and eliminate the dogs. I think that there is a benefit to that, But what's important is to make sure that your positions are diverse fied. So what's perverse about this is I could have ten stocks and be more diversified than if I own one hundred socks, because as long as those ten stocks don't zig and zag the
other they might be in different sectors. They might be different you know, some might be growth or value or defensive. I might be more diversified owning ten stocks than if I owned lots and lots of stocks that you know, that are highly correlated. So I think it's a combination of the number of positions. But whether you're diversify, which I'm fully in favor of, really depends on what is the correlation the relationships of the stocks and the portfolios.
So there's no magic number where at x number of shares you're really diversified. It depends on the companies themselves, the sectors are in, what various factors and qualities they have. Is that a fair way to describe that.
That's that's exactly right, That's exactly right. I mean, here, here's a great example. We own in our fund in Nvidio, but we also own Massacard and you'd say, oh wow, in videos you know a tech company, it's a semiconductor company, h and Massacard is a finance transactional company. So boy, they that's those stocks don't jig and zag the other
they're they're not correlated. Well, actually they are because they're both large cap growth stocks, And at the end of the day, as we've discussed in the past, very stocks move with their with their factor. Right, those are both growth stocks. So with growth stocks work, those will work together, and growth stocks don't work, they won't work together. So understanding the correlations is more than just well what sect do they they fall into?
So previously we've discussed active share. What does that mean in the world of concentrated portfolios? How much active share do you need to make a concentrated set of holdings look different than the index?
Well, you know this. Studies show that you need to have active share of somewhere between eighty and ninety percent, which means ninety percent of your of your portfolio differs from the the index. Now, I'm a believer in owning stocks that are in your benchmark, but just not owning many of them. You could have high active share again
by owning stocks that are not in the index. But over time, the higher your active share, the better managers do because if you only own say twenty stocks, it's going to become pretty apparent whether you're good or not because you're not kind of moving on a daily basis with the index. And so there is survivor, as I call survivorship bias. But higher active shares proven to outperform lower act to share over time.
So I know you're a fan of various market factors like value, quality, and momentum. How does that fit into the equationion of a concentrated portfolio?
Just academically, we know that any stock, and I'll go back to Nvidia, it is a large cap technology growth stock, and over time or Apple, same thing. Large cap growth technology stock, about two thirds of its return in any one year can be defined by those what I call factor exposures. Only a third comes from what's going on at the company level. So, in other words, as a portfolio manager, I need to make sure that I understand what is going to work in the future. Are we
an environment where growth stocks are going to work? Are we environment work value stocks are going to work. Value has a little bit more inflation sensitivity, and so value stocks have worked recently. So I think understanding those large factors has to play into it. I can't just put my blinders on and say I'm just going to buy twenty stocks that you know I love fundamentally and I'm
not going to look at anything else. I've seen so many managers that have made that mistake is they don't focus on the bigger factors as well, and so we play into that. And that's why I go back to that Invidia versus master Card example, which is on the surface two different sectors, but they are both growth stocks
and therefore they will move with the growth factor. So if I have twenty stocks and I don't want to have just exposure to the growth factor, I better go find another finance stock that's not correlated to the growth factor. Say you know a bank or whatever.
Given your concentrated portfolios twenty internationally thirty domestically, how much more risk is contained in that small number of stocks versus your benchmarks that in some cases are five hundred or sixteen hundred different names.
That is true, but there are very very large stocks in the index today. And if you you know, in our global concentrate, we don't own app well, Apple had a very tough, good, tough first quarter, so that added a lot of relative performance to our portfolio because it's a big waiting in the index. So I just I think it's understanding what is the makeup of the index and identifying stocks you think will work and ones in being underweight, the ones that won't work.
And what about different regions? Can you run a concentrated portfolio with a global tilt very separate from the US.
If I said to you, Barry, I want to run a portfolio for you, and I want to just be able to buy the best companies I can find that I think I can make the most money for you, and I don't care where they come from, just the best opportunities. Would you say yes to that more than Barry? I just I want to buy only European stocks for you, or only you know, emerging markets, or only this region
or only this style. What would you jump at? And I just always remember I was out of conferences about ten years ago and in London and this international manager says to me, so, Andrew, you run a global concert. There was global fun. How you know what European banks do you invest in? And I said, I don't have a single European banks. Wow, you can't do that. It's in my European benchmark. I don't like European banks either,
but I got to own them. And it was really at that point I thought, you know, this is crazy. Let's just let's just find the best ideas we can, you know, around the world and just have a limited number of them. I just think that that's, you know, it's a better approach than presuming that you can allocate to these specifics, regions or styles, because managers then they're going to buy things that they may not want to own because they're in the index.
You are one of the few active managers I am familiar with who seem to also embrace passive indexing. Tell us a little bit about how a concentrated portfolio matches up with a broad index.
Look, Barry, I've got no problem with people getting market exposure, but there is a place for active management, and I'm a believer in finding great companies and making sure they're all they're not, you know, they're not highly correlated, and it's sticking with them. When I'm absolutely not a fan of is low act to share mutual funds that own
lots and lots of positions. And the number of times I read Oracles Berry where someone says, oh, I love this stock, it's my favorite position, and then you know, you look up and they have a one and a half or two percent positions. Well, you know that's ridiculous because even the stock doubles. You know, they're not they're not really they don't really believe in those companies if they own you know, uh, small positions. So you know,
my the my enemy is not passive strategies. My enemy is really, uh, it's the closet, the closet indexers, because I think they're bringing a bad name to you know, to active managers. So I I I embrace, uh, passive strategies. I have. You know, I have passive strategies in my personal portfolio, but I have active managers that I know have done very well over time, and I've stuck with them, and you know it's work. So there's a place for both. It's just the closet indexers. There's no place for.
So to wrap up. If you're going to go active, well, then go active. Own a percentage of your portfolio in a concentrated set of holdings with an active manager with a high active share that marries up well to an inexpensive passive index, and it improves the odds of outperforming the broad indices. It can add a little sizzle to a conservative set of market holdings. I'm Barry Ridolts, and this has been Bloomberg's at the Mire.
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