Highly aggressive, concentrated portfolios need not have any more absolute risk than funds which tra...
Highly aggressive, concentrated portfolios need not have any more absolute risk than funds which track market indices, according to Ed Burke, manager of the Invesco Perpetual UK Aggressive fund.
He said the FTSE All-Share Index in itself is high risk, in absolute terms, because of its concentration of the largest companies. The top 15 stocks in the market, ranked by their weighting, account for 52.36% in the All-Share, while the top five alone account for 31.9%.
'So if one had a completely indexed portfolio, over half the assets would be accounted for by 15 stocks and almost one third would be tied to the fortunes of just five companies. This is a highly concentrated portfolio by any standard,' he said.
Meanwhile, the Invesco Perpetual UK Aggressive fund, which is marketed as a high risk product, has a similar level of absolute risk. Its top 15 holding account for around 55% of the portfolio, but the top five represent a much smaller proportion at 21%.
'The All-Share has become increasingly dominated by large cap stocks since 1994 and has been getting riskier and more distorted, during a period in which indexation and benchmarking have been growing in popularity,' he said.
Burke said even before the tech bubble, there was another bubble emerging ' the index bubble. And just as with the unwinding of tech recently, many of these big stocks have underperformed and been a drag on the market. Hence, over the past three years the FTSE All-Share has underperformed the FTSE 250 by 27%.
The other problem with the benchmark-based approach is that there are distortions in portfolio construction. Stocks are held simply because of their weighting in the index, not through the fund manager's conviction.
Burke points to the growing popularity of hedge funds, which provide absolute returns, even in down markets. Focussed funds, he said, are the mutual fund industry's response to these absolute return products.
Focused funds do have some advantage over hedge funds, for example greater liquidity and visibility, and lower costs, particularly if you take into account performance fees.
Also, though lack of leverage may limit returns in focus funds, it also means there is less short-term pressure and it is possible to exploit medium and long-term opportunities, Burke added. He said he expects to see a significant number of new focus fund launches, and that will improve choice and that this would create the opportunity for funds of focused funds.
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