Putting Your Investment Eggs in One Basket

by | Feb 18, 2000 | POLITICS

Stock market indexes and market leadership has been growing increasingly concentrated in a small number of stocks and sectors. Professional portfolio managers often react to this market concentration by allocating more money to fewer stocks, reducing their diversification and increasingly making “big bets” in their attempts to beat their benchmark. The growing acceptance of this […]

Stock market indexes and market leadership has been growing increasingly concentrated in a small number of stocks and sectors. Professional portfolio managers often react to this market concentration by allocating more money to fewer stocks, reducing their diversification and increasingly making “big bets” in their attempts to beat their benchmark.

The growing acceptance of this behavior was symbolized last week by Fidelity’s proposal to let its Magellan fund, the world’s biggest mutual fund, put more of its money in a single stock and own bigger stakes in some of the companies in the fund.

Under the proposals, Magellan could exceed current guidelines that bar the fund from investing more than 5 percent of its assets in a single company, and could use as much as 25 percent of its assets for investments that exceed the 5 percent investment threshold. For example, the proposal would let the fund invest 25 percent of its assets in one company, or 10 percent in one company and 15 percent in another.

There are several reasons Fidelity may be pursuing this change. One is that in the S&P 500 index, against which Magellan benchmarks, some stocks, like Microsoft, are getting closer to a 5% weight. If this trend continues, Magellan would be prevented from matching or going above index weights on the market’s largest stocks. Fidelity may also be anticipating more mega-mergers like AOL-Time-Warner that would create even bigger companies, and representing greater than 5% of market value.

Or what about the possibility that the Magellan manager would like to catch up to his benchmarks by putting more of his chips on a few numbers? That doesn’t seem out of the realm of possibility. After all, the portfolio manager must’ve seen that most of the top-performing mutual funds in 1999 were poorly-diversified funds, with just a handful of hot holdings, and might have felt pangs of envy and regret.

Of course, such a move by Magellan could magnify returns positively or negatively, and would almost certainly increase the riskiness of the portfolio, but if I were a shareholder, which I’m not, I’d approve Fidelity’s proposal. After all, the Magellan fund may need this kind of flexibility just to match index weights. And all of the other Fidelity “growth” funds have similar flexibility. But I’d watch their investment strategies even more closely afterwards. The Fidelity Magellan fund at the end of December had assets of $106 billion. If Fidelity put $26 billion into one stock, it would almost certainly have a market impact, both coming in and going out. For example, $26 billion would buy about half of General Motors’ stock, and realistically, I think they’d only try such a maneuver on the largest stocks.

The symbolism is clear – the recent trend in portfolio management is to own fewer, bigger, hotter positions. High returns are in; careful risk-management is out (unless, of course, you’re talking about the risk of being left out of a hot tech rally and thus not getting a big year-end bonus).

Andrew West is a Contributing Economics Editor for Capitalism Magazine. In 1997 he received the Chartered Financial Analyst designation from the Association for Investment Management and Research.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

Related articles

No spam. Unsubscribe anytime.

Pin It on Pinterest