“Status quo bias”: Nomura blasts pervasive low-conviction investing

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Fund managers should invest with higher concentration in their “best ideas” to maximise potential for outperformance, according to Nomura Asset Management.

The asset manager says that over 60 per cent of Large Cap Active Global Equity funds in a popular database have more than 50 stock holdings, while almost 40 per cent hold more than 80 stocks.

This implies an average investment of 2 per cent or less in individual investments, which Tom Wildgoose, co-manager of Nomura Global High Conviction Fund says “seems quite low, especially for a best idea”.

Investors may be able to infer what a portfolio manager thinks of a stock by the amount invested in it, he continues.

Using probability-weighted outcomes, a 3 per cent position in a stock implies that the fund manager sees the idea as having equal upside and downside, but with an upside probability of 51.5 per cent. 

“This does not sound very convincing, and of course the manager is unlikely to agree with that range of outcomes and probabilities. So why not concentrate the portfolio on the few best ideas and forget about the rest?” writes Wildgoose.

Wildgoose says that “status quo bias” leads many fund managers pad out their portfolios with many low-concentration investments.

“There are several reasons which largely fit under the heading of “status quo bias”, that is to say, it has been this way for a long time,” writes Wildgoose.

“However, other factors are important such as the loss aversion of investors and managers (as humans), where underperforming significantly feels emotionally much worse than outperforming significantly feels better.”

Staying closer to average performance is “safer” for portfolio managers.

“With a more concentrated portfolio a wider divergence from average is more likely, but if you fear losses more than you welcome wins then the payoff structure, even when winning is more likely, can be skewed to the downside,” says Wildgoose.  

Some degree of benchmark-hugging may also help an investment manager retain clients, as many may be willing to accept a “small underperformance, but not a large one, and are not materially happier with a large outperformance than a small one”.

Nomura’s analysis finds that “additional stocks beyond 40 reduces your chance of outperformance but does not reduce your portfolio volatility much”. 

On the other hand, holding below 10 stocks is “too concentrated” since there are not sufficient stocks to diversify portfolio exposures. “Since more stocks underperform than outperform over time, you will tend to get a downside skew in the deviation of returns from the average,” says Wildgoose. 

“Of course there is a chance of huge outperformance, but there is more chance of huge underperformance and/or bigger underperformance than outperformance.” 

The all-time highest conviction investments in Nomura’s Global High Conviction fund have each accounted for around 8 per cent of the portfolio.

Internet service provider Alphabet, healthcare provider DaVita, and house-builder NVR, are among the stocks in which Nomura is currently invested with high conviction, seeing potential for long-term growth and margin improvement.

Ultimately, Wildgoose believes fund managers’ skew towards low concentration is unlikely to change. 

“There does not appear to have been much change in the degree of concentration in funds over many years and there is strong emotional and commercial logic for incumbents, in particular, to continue with the historic approach. Therefore I doubt there will be much change even though the logic of increasing concentration is clear,” he says.

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Madeleine Taylor
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