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Rising Concentration Points to New Risks

These funds have become more concentrated among top holdings during the past three years.

Securities In This Article
Universal Health Services Inc Class B
Bausch Health Companies Inc
Royce Small-Cap Special Equity Invmt

That’s not to say investors should avoid concentrated funds. Patient investors with long horizons may find much to like with them. In fact, Morningstar’s analysts assign Sequoia a Morningstar Analyst Rating of Gold, reflecting their view that it is a best-of-breed fund for investors willing to ride out short-term bumps. Still, it is worth noting when a fund’s concentration markedly changes. Hopefully investors realized that Sequoia’s stake in Valeant had more than tripled as a percentage of the portfolio during the past three years. Keeping an eye on such changes helps keep investors apprised of the risks they face.

To identify situations where concentration risk has grown, we screened the Morningstar 500 for funds that have meaningfully increased their allocation to their top 10 holdings during the past three years. While the funds below don’t carry as much stock-specific risk as Sequoia, the recent changes still merit consideration.

Westport WPFRX has also consolidated its portfolio. During the past three years, the fund’s number of positions has fallen to 32 from 50, while its top 10 names have grown to 54% of assets from 31%. It is nice to see that the top holdings have long held spots in the portfolio. Universal Health Sciences UHS, the largest position at 8% of assets, was first bought in December 2008, and all of the other top 10 names were purchased in 2011 or earlier. Longtime skipper Ed Nicklin is in his late 60s, and the firm’s co-owner Andy Knuth is in his mid-70s, which raises concerns about succession planning, another reason to be cautious.

Delafield Fund DEFIX has about 40% of assets in its top 10 positions, marking a notable increase from 25% three years ago. It focuses on small- and mid-cap companies and holds no more than 5% of assets in any stock. While that may not seem to court significant company-specific risk, the fund stands out versus small- and mid-cap competitors, which tend to have more-diversified portfolios compared with large-cap strategies. The average small-cap fund holds 22% of assets in its top 10 holdings, while the typical mid-cap strategy stashes about 27% of assets in its 10 largest positions. Delafield is also concentrated from a sector standpoint, with 82% of the portfolio invested in just three sectors: materials, industrials, and information technology.

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About the Author

Leo Acheson

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Leo Acheson, CFA, is director, multi-asset ratings, global manager research for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc.

He oversees Morningstar’s multi-asset ratings as well as the firm’s multi-asset and alternatives manager research team. The group covers a range of investment vehicles, including allocation strategies, alternatives, target-date funds, 529 plans, HSAs, model portfolios, and Mexican pension funds.

Before joining Morningstar in 2013, Acheson spent four years working for a Chicago-based investment consultant, conducting mutual fund and asset-class research to help corporations manage their investment programs.

Acheson holds a bachelor’s degree in finance and accounting from Indiana University’s Kelley School of Business. He also holds the Chartered Financial Analyst® designation.

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