In the late 1990s, Janus Twenty (JAVLX), Marsico Focus (MFOCX) and other funds made bold bets on relatively few stocks, usually in such high-octane sectors as technology and telecom. By thumbing their noses at broad diversification and typically holding 20 to 40 stocks, these compact portfolios trounced the average U.S. equity fund, with 157 picks.
Now that Janus Twenty has lost an average 24% of its value annually over the past three years -- after soaring 73% in 1998 and 65% in 1999 -- pursuing a focused strategy hasn't seemed so smart during the bear market. Or has it? Some focused funds, especially those that avoided tech sector blowups, have thrived. Oakmark Select, a 20-stock value fund, has returned an average 11% since 2000, while Longleaf Partners, another value fund, is up an annualized 9.1%. By comparison, U.S. stock funds overall have lost an average 8.8% annually during the same period.
What's more, focused funds as a group have proved to be winners over longer periods that span bull and bear markets. Janus Twenty, for instance, has staged a modest rebound in 2003, up 6.7%. Ditto for Marsico Focus, which has gained 8.7% so far this year after losing an average 12% of its value annually over the past three years. In a recent study, Standard & Poor's (MHP) (like BusinessWeek, a unit of The McGraw-Hill (MHP) Companies) found that funds with concentrated portfolios rose at a 9.29% average annual clip in the 10 years ending Mar. 31, compared with 8.31% for nonconcentrated funds. The study examined 140 funds with at least 30% of their assets in their top 10 holdings. Of these, 32 fell into the focused category, holding 40 stocks or fewer.
Morningstar senior analyst Gregg Wolper says the focused concept is a sound one. "The idea is to put most of the fund's assets behind a relative handful of picks that the manager has the most conviction in," he says. Adds Phil Edwards, managing director of funds research at S&P: "When these managers pick good stocks, their results aren't diluted by diversification." And by limiting the number of companies, fund managers can monitor these holdings more closely.
BAD APPLES. The downside is that a couple of bum stocks can throw off performance. So if you're interested in this genre, it's important to select an offering run by a manager with a proven track record -- someone like much-heralded stock-picker Bill Miller. As head of the $8.6 billion Legg Mason Value Trust (LMVTX) Miller has beaten the S&P 500-stock index for 12 straight years -- the only fund manager to do so. What you might not realize is that Value Trust is a concentrated fund with just 32 stock holdings. Miller's record is even better at the three-year-old Legg Mason Opportunity Trust (LMOPX) which has just $1.5 billion in assets and holds 30 stocks. Opportunity Trust is up 26.3% this year (through May 12), vs. 13.9% for Value Trust.
Similarly, Ralph Wanger, manager of Liberty Acorn (ACRNX), one of the most successful small-company funds around, has a better record this year with Liberty Acorn Twenty (ACTWX) The more concentrated fund, which invests in mid-cap stocks, has risen 9.97% so far, while Liberty Acorn -- with 269 stocks -- has gained 8.93%.
Once you find a focused fund you like, be prepared for a wild ride. Take CGM Focus (CGMFX) up 14.9%, on average, over the past five years. Because manager Ken Heebner makes huge sector bets, which usually pay off but sometimes miss, returns have been erratic over shorter periods. Over the past year ended May 12, for instance, CGM Focus is off 22%.
Because of their high risk, such funds should not be your sole holding. But if you have a good chunk of your assets in index funds or broadly diversified mutual funds, focused funds have the potential to juice up your returns.
Fund watchers estimate that some 200 focused funds are available. But you have to dig to unearth them. For one thing, funds that have the word "focus" or "focused" in their name aren't always concentrated. Fidelity Focused Stock (FTQGX) fund, for instance, holds 67 stocks, and FMI Focus owns 86. They are so-named because they define "focused" more loosely. Conversely, many focused funds lack the telltale words "focused" or "select" in their names. The only foolproof way to see what's what is to examine a fund's portfolio. Fund reports and databases usually tell the number of stocks a fund holds. If it's 40 or fewer, the fund is considered focused.
Whichever fund you choose, keep close tabs on its performance. With so little margin for error, focused funds aren't the type you buy and forget. By Susan Scherreik