UK markets closed

Is Diversification Damaging Your Returns?

candies

Diversification is one of the first rules that any investor learns; spreading your money across lots of different holdings can reduce your risk and lead to steadier returns over the long-term.

We looked at funds that have between 150 and 350 holdings and found that on average a diversified fund charges 0.74% and beats its Morningstar Category average by only 1 percentage point over a five year period. 

Funds with 100 or more holdings in their portfolio are typically thought to be well diversified. A fund with 100 stocks in the portfolio, for example, might have roughly 1% of its assets in each holding. The benefit of this, it is argued, is that if one holding falls, the effect on the fund's overall performance is limited. On the face of it, it's a sensible strategy. But can too much diversification actually mean mediocre returns? 

"If you want more outperformance, you probably want to choose a fund that's more active," says Chris Traulsen, director of fund research at Morningstar. "If you invest in a concentrated fund and its manager does a great job, picking all the right stocks, the returns will be greater than those produced by diversified funds." 

We found 34 UK-domiciled funds with between 150 and 350 holdings that are dominated in pounds or dollars (some funds had more holdings, but we capped our data set at 350). But just four of these funds beat their Morningstar Category average by more than 3 percentage points over five years.

How Do Diversified Funds Perform? 

The 11 sterling-denominated funds in the table below and on average they beat their peer group over five years by only 0.45 percentage points.

The three-star rated Axa Rosenberg Global fund has the largest number of holdings in the list at 339. The fund's largest holding is US tech firm Microsoft, accounting for 2.53% of assets. The top 10 holdings account for just 13.58% of assets in total. The fund has produced annualised returns of 10.84% over five years, beating the Global Large-Cap Blend Equity Morningstar category by 1.55 percentage points a year.

The weakest performer in the list is the two-star rated Dimensional UK Value fund, whose annualised returns over five years are some 2.13 percentage points behind the category average. Surprisingly, despite having 209 holdings in the portfolio, the largest 10 positions account for around 44% of assets. 

diversification

The JPM UK Equity Core fund, meanwhile, has produced annualised returns of 6.79% over five years, 1 percentage point more than its category. Callum Abbot, manager of the fund, argues that diversified funds are not necessarily designed to deliver high returns. 

The fund, which has 155 holdings, aims to beat its benchmark, the FTSE All Share, and cover its fee while being low risk. "People can use the fund as an alternative to a passive fund since we have a better track record and are still cheap, or it can be a core portfolio holding that investors can build risk around," he adds. 

To manage risk, the fund can only deviate slightly from its benchmark - holding up to 0.3% more or less in a stock than the index. For this reason, even though he really likes Games Workshop, for example, just 0.4% of the fund's assets are in the stock. 

“[With this style of investing] you have smoother, more consistent performance, with no big swings month by month. If one stock doesn’t perform well is not going to blow up the performance of your portfolio,” Abbot adds.

Managers with a concentrated portfolio often consider themselves as owners of the stocks they invest in, rather than just short-term investors. A manager who is monitoring hundreds of holdings is understandably unable to have such a close relationship with the companies he backs.

Jan Sytze Mosselaar, equity manager at Robeco, says: "The disadvantage is that we don't know all our holdings in depth. But our aim to have exposure to different sectors and the best way to achieve that is having lots of different names in the porfolio." 

He also points out that not being so close to a company can make it easy to avoid the investment mistake of holding on to a loser: “If a company has a profit warning, I prefer not to hold to that position anymore rather than waiting it gets better.” 

How Much Diversification is Too Much?

The traditional argument against holding just a handful of stocks in an investment portfolio is that it ramps up the risk - if one stock tumbles it can have a significant effect on overall performance. But a recent Morningstar investigation found that some of the most concentrated portfolio have produced consistently stellar returns. 

For Morningstar analysts, there is no blanket rule on how many holdings a fund should have. The appropriate number depends on factors such as a fund's investment goals and its manager's investment style. Investors looking for a defensive option with low volatility may find a widely diversified fund is the best option for their needs. 

But Traulsen points out that the number of holdings in a fund is not always the most important point, rather investors should consider the weighting of the positions. “You can have a big chunk of assets in the top 10 holdings and then a long tail of small positions,” he explains.

For example, the Russell Investments Continental European Equity fund has 316 holdings and just 18% of its assets in the biggest 10 positions, while the Dimensional UK Value fund has 44% of its assets in its top 10 holdings, despite having more than 200 holdings. 

One major benefit of a diversified fund, adds Traulsen, is liquidity. A larger number of smaller positions makes it easier for a manager to trade in and out than if he holds a large stake in a few stocks. 

But there are downsides to holding a larger number of stocks, too. One of the most obvious is cost; buying and selling shares costs money, so if a manager has hundreds of positions he may rack up far greater trading costs than a manager who is managing just a handful of stocks. 

Checking the ongoing charge is crucial when considering any fund and is a helpful indicator in this case too. A fund that doesn’t take on much risk or deviate from its benchmark, but charges a high is "problematic”, Traulsen says.

  • Trump to hold call with U.S. internet, mobile phone providers
    Finance
    Reuters

    Trump to hold call with U.S. internet, mobile phone providers

    President Donald Trump is holding a call with seven of the biggest U.S. internet and mobile phone providers on Tuesday to talk about how the networks are holding up as tens of millions of Americans work from home. The Federal Communications Commission has said U.S. networks are performing well and has

  • Carnival cruises seeks $6bn funding amid coronavirus fallout
    Finance
    The Guardian

    Carnival cruises seeks $6bn funding amid coronavirus fallout

    Carnival cruises seeks $6bn funding amid coronavirus falloutWorld’s largest cruise operator and owner of Diamond Princess admits sector may never recover from pandemic * Coronavirus – latest updates * See all our coronavirus coverage

  • 'It's a war, it's a disaster'
    News
    Sky video

    'It's a war, it's a disaster'

    Sky visits Cremona hospital in Lombardy where staff face a fight to save every patient.

  • Senators urge U.S. airlines to issue ticket refunds after bailout
    Finance
    Reuters

    Senators urge U.S. airlines to issue ticket refunds after bailout

    Nine Democratic U.S. senators on Tuesday urged the chief executives of 11 major airlines to issue full cash refunds to customers cancelling flights during the coronavirus pandemic after Congress approved $25 billion (20.17 billion pounds) in cash grants for the hard-hit industry. "We believe your

  • UK supermarkets ease coronavirus shopping restrictions
    Finance
    The Guardian

    UK supermarkets ease coronavirus shopping restrictions

    UK supermarkets ease coronavirus shopping restrictionsAldi, Lidl, Morrisons and Waitrose relax quantity curbs after decline in footfall * Coronavirus – latest updates * See all our coronavirus coverage

  • Coronavirus clampdown prompts British professional services to cut costs
    News
    Reuters

    Coronavirus clampdown prompts British professional services to cut costs

    Britain's coronavirus lockdown began taking its toll on London's financial heartland on Tuesday as accounting and consulting group Grant Thornton and law firm Allen & Overy sought to cut costs, including pay, and bolster capital. In normal circumstances Grant Thornton and Allen & Overy advise

  • More orders for NHS ventilators take number to 61,000
    Finance
    The Guardian

    More orders for NHS ventilators take number to 61,000

    More orders for NHS ventilators take number to 61,000Cambridge company Sagentia says prototype can be produced at speed for Covid-19 patients * Coronavirus – latest updates * See all our coronavirus coverage

  • Munich Re withdraws profit guidance due to coronavirus claims
    Finance
    Reuters

    Munich Re withdraws profit guidance due to coronavirus claims

    Munich Re on Tuesday withdrew its profit guidance for the year, blaming heavy insurance claims triggered by the cancellation of large events which were banned as a way to stop the spread of the coronavirus. Munich Re said claims made to its property-casualty reinsurance segment had caused it to anticipate

  • I’d fill my Stocks and Shares ISA with these FTSE 100 bargains
    Finance
    Fool.co.uk

    I’d fill my Stocks and Shares ISA with these FTSE 100 bargains

    After a disastrous quarter, Cliff D'Arcy thinks brave investors should dive deep into the FTSE 100's bargain bucket for treasure!The post I’d fill my Stocks and Shares ISA with these FTSE 100 bargains appeared first on The Motley Fool UK.

  • Investing for income in a down market
    Finance
    Fool.co.uk

    Investing for income in a down market

    Many businesses may be struggling, but there are still good income stocks if you know what to look for.The post Investing for income in a down market appeared first on The Motley Fool UK.

  • Garment exporter Bangladesh faces $6 billion hit as world retailers cancel orders
    Finance
    Reuters

    Garment exporter Bangladesh faces $6 billion hit as world retailers cancel orders

    Bangladesh, the second-largest apparel producer after China, is set to lose roughly $6 billion (4.83 billion pounds) in export revenue this financial year amid cancellations from some of the world's largest brands and retailers, two major industry bodies said on Tuesday. The two groups, which represent

  • FTSE posts worst quarter since 1987 amid virus fears despite rally
    Finance
    PA Media: Money

    FTSE posts worst quarter since 1987 amid virus fears despite rally

    London’s top flight closed 108.22 points higher at 5,671.96 at the end of trading on Tuesday.

  • U.S. consumer confidence approaches three-year low
    Finance
    Reuters

    U.S. consumer confidence approaches three-year low

    U.S. consumer confidence dropped to a near three-year low in March as households worried about the economy's near-term outlook amid the coronavirus pandemic, which has upended life for Americans. The survey from the Conference Board on Tuesday came in the wake of reports last week showing the number

  • FTSE 100 housebuilders: Why I don’t buy them for dividends
    Finance
    Fool.co.uk

    FTSE 100 housebuilders: Why I don’t buy them for dividends

    If your goal is to generate regular dividends, FTSE 100 (INDEXFTSE: UKX) housebuilder stocks should be avoided, says Edward Sheldon. The post FTSE 100 housebuilders: Why I don’t buy them for dividends appeared first on The Motley Fool UK.

  • Britain waives import taxes on medical equipment
    News
    Reuters

    Britain waives import taxes on medical equipment

    Britain has waived import taxes on medical equipment, including ventilators, coronavirus testing kits and protective clothing, finance minister Rishi Sunak said on Tuesday, in an effort to improve the supply of goods to hospitals. Britain is bracing for the peak of the coronavirus crisis which is expected

  • Will panic buying help the Sainsbury share price?
    Finance
    Fool.co.uk

    Will panic buying help the Sainsbury share price?

    Panic buying may be bad for consumers, but the supermarkets may be making a killing.The post Will panic buying help the Sainsbury share price? appeared first on The Motley Fool UK.

  • Tax avoidance schemes target workers answering NHS call-up
    Finance
    The Guardian

    Tax avoidance schemes target workers answering NHS call-up

    Tax avoidance schemes target workers answering NHS call-up. Recruits to coronavirus appeal may end up owing tax, interest and fees, warns HMRC

  • Tesco recruits 35,000 workers to get through coronavirus crisis
    Finance
    Reuters

    Tesco recruits 35,000 workers to get through coronavirus crisis

    Britain's biggest retailer Tesco said on Tuesday it had recruited 35,000 additional workers in the last 10 days to help get it through the coronavirus emergency, which has triggered a dramatic increase in demand for groceries. The supermarket group is the country's largest private sector employer

  • Don’t sell your shares! Moving into cash during a stock market crash will destroy your wealth
    Finance
    Fool.co.uk

    Don’t sell your shares! Moving into cash during a stock market crash will destroy your wealth

    If you sell your shares and move into cash today, you will regret it when the stock market crash is over.The post Don't sell your shares! Moving into cash during a stock market crash will destroy your wealth appeared first on The Motley Fool UK.

  • Goldman Sachs slashes U.S. GDP estimate further
    Finance
    Reuters

    Goldman Sachs slashes U.S. GDP estimate further

    Goldman is now forecasting a real GDP sequential decline of 34% for the second quarter on an annualised basis, compared with its earlier estimate for a drop of 24%. It also cut its first-quarter target to a decline of 9% from its previous expectation for a 6% drop, according to chief economist Jan Hatzius

  • Finance
    Reuters

    Plant shutdowns hit 1.1 million auto workers in Europe - ACEA

    The coronavirus crisis and plant shutdowns have affected the jobs of at least 1,1 million Europeans working in automobile manufacturing, the European Automobile Manufacturers’ Association (ACEA) said on Tuesday. The wider sector provides jobs for 13.8 million people across the European Union, ACEA said

  • EasyJet grounds entire fleet. Should you invest in airline stocks in this market crash?
    Finance
    Fool.co.uk

    EasyJet grounds entire fleet. Should you invest in airline stocks in this market crash?

    Shares in airline operators have plummeted in the stock market crash. But does that mean now is a good time to invest?The post EasyJet grounds entire fleet. Should you invest in airline stocks in this market crash? appeared first on The Motley Fool UK.

  • OPEC rift widens as group fails to set date for emergency talks
    Finance
    Reuters

    OPEC rift widens as group fails to set date for emergency talks

    MOSCOW/LONDON (Reuters) - A rift in the Organization of the Petroleum Exporting Countries (OPEC) has widened after members failed to agree unanimously on an emergency low-level meeting to discuss a market collapse that has seen global oil prices hit 18-year lows. OPEC president Algeria, which has been

  • Buying FTSE 100 shares right now? Here’s what you need to know
    Finance
    Fool.co.uk

    Buying FTSE 100 shares right now? Here’s what you need to know

    Investing in FTSE 100 (INDEXFTSE: UKX) stocks has become far more challenging due to the coronavirus, says Edward Sheldon. The post Buying FTSE 100 shares right now? Here's what you need to know appeared first on The Motley Fool UK.

  • Forget high dividend yields! Here’s how I’m buying FTSE 100 stocks in the market crash
    Finance
    Fool.co.uk

    Forget high dividend yields! Here’s how I’m buying FTSE 100 stocks in the market crash

    Income investing is on shaky ground as FTSE 100 companies cut dividends. But there are other investing styles to explore.The post Forget high dividend yields! Here's how I'm buying FTSE 100 stocks in the market crash appeared first on The Motley Fool UK.