Fundsmith Equity, Lindsell Train Global Equity, CFP SDL UK Buffettology: some of the most successful managers are often the high conviction managers running concentrated portfolios of stocks. 
But for some investors the fact that managers own just a handful of equities can lead them to believe they are exposed to potentially greater stock-specific risk and volatility, which can be off-putting.
However, Invesco fund managers Stephen Anness (pictured) and Andrew Hall said that a high-conviction, concentrated portfolio provides with the best chance of delivering long-term outperformance for clients.
Below, the pair – managers of the £218.7m Invesco Global Opportunities fund – highlight five reasons why investors should consider high conviction fund managers.
Markets are broadly efficient; compelling investments are rare
The first reason highlighted by Anness and Hall is that while there are typically thousands of analysts covering stocks, markets are inefficient.
Although price discovery is generally fast and effective, they claimed “pockets of inefficiency” can be found thanks to investor psychology, sentiment and behaviour.
As such, when the opportunities appear the pair take advantage by backing them with a high conviction.
“Compelling valuation anomalies are rare,” they said. “This lends itself to having a concentrated portfolio allowing us to back those rare anomalies with conviction.”
Adding more stocks dilutes your best ideas
Another benefit of concentrated portfolios over more diversified strategies, according to the pair, is that adding more stocks can lessen the impact of high conviction investments.
“While the common argument is that diversification can reduce risk, we believe that, beyond a certain point, it actually adds to risk as you are inevitably forced to add more marginal ideas,” the Invesco managers said.
“We seek to maintain strong competition for capital and judge each new idea on its own merits.”
In addition, the more stocks from a manager’s investable universe that are added to a portfolio the more it starts to resemble the benchmark.
“The more closely you resemble the index, the lower your odds of delivering a different – hopefully better – outcome then the index,” they added.
Circle of competence
The third reason investors should back a high-conviction approach, the Invesco managers argued, is that a concentrated portfolio with low turnover only requires a small number of ideas to be generated each year.
As such, Anness and Hall said that they are able to avoid companies that are difficult to understand and analyse unless they feel there is adequate compensation.
“This way, we also don’t need to be experts on every company, sector or country – we believe that remaining within our circle of competence is an important way to reduce risk,” they said.
Better in-depth knowledge
Investing in just a handful of companies means that more time can be spent in understanding each business held in the portfolio.
This allows managers to analyse financials, meet management and get to know their products, customers and competitors, which ultimately leads to more informed investment decision, said the Invesco Global Opportunities managers.
“On the flip side, a fund that owns too many stocks may increase the possibility of failing to spot important new information relevant to the investment thesis,” said Anness and Hall.
“Holding fewer stocks also facilitates maintaining a relatively small team, which can be highly functional, collaborative and agile in its research focus.”
Academic conclusions
The pair also highlighted academic backing for concentrated portfolio outperformance and in particular Antii Petajisto and Martijn Cremer’s research on ‘active share’.
“The paper concluded that those with high active share – the smallest overlap with their benchmark – are expected to outperform those with low active share – biggest overlap,” they said.
“By definition, a concentrated global portfolio (35-40 stocks) is highly likely to have a high active share when judged against the MSCI ACWI benchmark of several thousand stocks.”
What about volatility?
One of the major causes for concerns for investors is that concentrated portfolios are more volatile than their more diversified peers given the narrow number of stocks they invest in.
While Edwin Elton and Martin Gruber’s ‘Modern Portfolio Theory and Investment Analysis’ found that increasing the number of stocks in a portfolio can reduce a portfolio’s volatility, the Invesco managers argued that reduction in volatility beyond 20 stocks is minimal.
“If volatility versus a benchmark is your preferred measure of risk, then you should seek to avoid active management entirely,” they said. “If you seek to achieve long-term alpha, then we would argue that an actively managed, concentrated portfolio is a good starting point.”
Anness has managed the Invesco Global Opportunities fund since January 2013 and is lead manager. Hall was named deputy manager from May 2014 and both were joined by Joe Dowling in November last year.
Despite the fund’s recent drop to a two FE Crown rating it remains on FE Invest’s Approved List, with analysts praising the fund’s team approach and process.
“Despite holding some considerable sector bets, the team insists this is a result of its strict valuation criteria, deeming some sectors too expensive to invest in,” the analysts said. “We are inclined to believe this, as stock selection has historically been the driver for the fund’s returns and active risk versus the benchmark.”
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
Since Anness was appointed to the fund, it has made a total return of 107.67 per cent, against a 107.91 per cent return for the MSCI AC World index and a 91.54 per cent gain for the average IA Global peer.
The fund has an ongoing charges figure (OCF) of 0.95 per cent.