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Take a global focus

As the global economic recovery begins to pick up and the outlook for equities looks more positive, there is an opportunity to capitalise on the upturn via a new breed of global stockpicking funds. These invest in a limited number of stocks with the aim of achieving superior performance.

After first looking briefly at the reasons behind the launch of global stockpicking funds, I shall turn to the factors that distinguish concentrated funds from conventional diversified funds and the advantages that the former have over the latter.

The Standard & Poor&#39s Micropal global growth universe includes a multitude of different funds covering all manner of investment styles and objectives. This universe encapsulates diversified global funds investing in up to 400 stocks – global sector funds – funds with a regional bias, such as the UK, and funds with no regional bias. But the eclectic nature of the funds in the global growth sector has led to dissatisfaction among some investors and investment managers, prompting the launch of a new type of global fund – the focus fund.

This is an emerging brand of opportunistic fund that concentrates characteristically on between 30 and 50 stocks and is designed to be a high-performance fund with an emphasis on stockpicking.

The bottom-up approach of such funds distinguishes them from the way that most investment houses have been managing global funds. Many managers have historically started with an asset allocation process to determine weightings within the main geographical regions. Based on this initial allocation, a number of region-specific teams in turn build separate portfolios.

The traditional approach has been inefficient from the point of view of both risk and return. A top-down approach that divides a given mandate and allocates each portion to regional teams fails to capture any benefit from being global. This is because the expected returns are built up in isolation and may counteract each other, unlike the unified returns associated with a bottom-up approach.

Over the last 10 years, many global growth funds were underexposed to the US yet bullish on Japan. Bottom-up investors would more probably have seen that the US, UK and Europe were undergoing a productivity miracle while Japanese companies were delivering poor and declining returns on equity.

In conventional portfolio construction terms, diversified portfolios have provided lower risk. Holding, for example, Japanese banks in a global portfolio in this sense was diversifying and risk-reducing. However, diversification did not stop these stocks providing negative returns or, in some cases, going bankrupt.

So, while a concentrated portfolio can be seen as riskier, the careful selection process of the manager can compensate for this risk.

The two views – top down and bottom up – are contradictory. Crucially, traditional asset allocation has failed to recognise micro-developments at the company level. Global stockpicking funds do not suffer from these problems and look set to take a firm foothold in the global growth sector.

The benefits of running a concentrated portfolio are many. First, the stocks in the fund must comprise the undiluted best buys coming from a fund management team&#39s research analysts. By holding a limited number of stocks, good-performing stocks will not have their contributions to the overall performance of the fund weakened. The stocks that comprise a concentrated portfolio must in themselves be from quality investment ideas.

We have seen concrete evidence of the benefits that can arise from separating the research team from the fund management team. This allows fund managers to enjoy the benefits of leverage by taking recommendation lists from their research teams and then narrowing these down to between 30 and 50 stocks.

Second, running a concentrated portfolio compels fund managers to follow strict buy and sell criteria to ensure that only the best names are included in the portfolio. When a stock hits a target price, the fund manager should sell and move on to the next buy idea. Consequently, they also have tougher selling disciplines.

Are concentrated funds the heirs apparent to the global growth throne? Ultimately, only performance figures can measure the success of concentrated funds and the results so far have consolidated our opinion that global stockpicking funds can and will perform well.

With the global recovery seemingly under way, concentrated funds can look forward to a bright future.


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