Fill your portfolio with your very best ideas
Fund managers’ top picks beat the market, but the rest of their portfolios often add little value, says Chris Sholto Heaton.


It’s widely accepted that your portfolio should be well-diversified to prevent a single disastrous decision from wiping out a large chunk of your wealth. At the same time, if a portfolio is too large, your chances of outperforming the market shrink and you might as well hold a cheap tracker fund.
These extremes are self-evident: the big question is the number of holdings that gives you the best trade-off between return and risk. Research by Miguel Antón of the University of Madrid, Randolph Cohen of Harvard Business School, and Christopher Polk of the London School of Economics gives us an interesting way to think about this. Their paper Best Ideas looks at how many of a fund manager’s highest-conviction stocks make a contribution to beating the market.
Based on holdings in US mutual funds between 1983 and 2018, they found that managers’ top picks outperformed the market by 2.8%-4.5% per year on average (depending on exactly how you measure risk-adjusted performance) – but this only extends to the top three-to-five highest-conviction ones. “The vast majority of the other stocks managers hold do not exhibit significant outperformance.”
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Drag on returns
If investors only have a few stellar ideas at any one time, this implies that portfolios pretty rapidly grow to the point where no potential alpha gets added. Given that many funds run portfolios of 50 or even 100 stocks, it’s obvious that the vast majority can’t contribute much and the extra cost and time of looking after them is a drag on returns. However, cutting the portfolio down too much means that risk soars.
With five stocks, the cost associated with one going badly wrong is vast – and even if all ideas ultimately work out, volatility along the way will usually be staggering. For institutions, one answer could be to divide a portfolio up by regions and industries, and hire different managers to run ultra-concentrated fivestock portfolios in each area, suggests Cohen in an interview with Citywire. The result would be a diversified portfolio, but one that does not simply replicate the market.
Private investors can’t do the same and in any case our portfolios are often quite concentrated. Still, this kind of thinking may help.
Does your portfolio consist of your very best ideas across several complementary sectors and strategies, or alternatively a smaller number of high-potential picks plus a cheap tracker to diversify away some of the risk? Or have you ended up with a large pool of similar stocks, all driven by the same factors? Do you hold a few distinctive focused funds? Or have you got a grab-bag of 100-stock monsters that just add up to the market portfolio?
In short, assume that you may only make a few good decisions, then try to do so in a way that gives the successes a chance to make a difference.
See also:
Sign up for MoneyWeek's newsletters
Get the latest financial news, insights and expert analysis from our award-winning MoneyWeek team, to help you understand what really matters when it comes to your finances.
Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.
Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.
He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.
-
City watchdog warning: wealthy savers hold too much cash
Damning FCA reports finds wealthy savers are holding £10,000 or more in cash, but should invest instead or risk stagnated returns.
-
Inheritance tax could be due on the average property in just 10 years
Rising house prices and frozen tax thresholds could mean inheritance tax is payable on the average home from 2035
-
Greg Abel: Warren Buffett’s heir takes the throne
Greg Abel is considered a safe pair of hands as he takes centre stage at Berkshire Hathaway. But he arrives after one of the hardest acts to follow in investment history, Warren Buffett. Can he thrive?
-
Who will be the next Warren Buffett?
Opinion There won’t be another Warren Buffett. Times have changed, and the opportunities are no longer there, says Matthew Lynn.
-
Will Comstock crash – or soar?
Opinion The upside for Comstock, a solar panel-recycling and biomass-refining group, dwarfs the downside, says Dominic Frisby.
-
'As AGMs go digital, firms must offer a new form of scrutiny for shareholders'
Opinion Technology has rendered big AGM meet-ups obsolete, but the board still needs to be held to account, says Matthew Lynn
-
Unilever braces for inflation amid tariff uncertainty – what does it mean for investors?
Consumer-goods giant Unilever has made steady progress simplifying its operations. Will tariffs now cause turbulence?
-
Two ways to tap into monopoly profits from airports
Most investors can’t get their hands on airports. Here are two ways you can
-
Fat profits: should you invest in weight-loss drugs?
The latest weight-loss treatments could transform public health and the world economy. Should you invest?
-
How investors could profit from Ramsden Holdings' four-part growth strategy
Ramsdens Holdings offers a diversified set of financial and retail services and a juicy yield, says Dr Michael Tubbs