Tuesday, March 20, 2018 Stamford, CT USA — The need for “alpha” among investors attempting to keep pace with growing and future liabilities given inadequate funding levels and low savings rates is fueling demand for focused investment strategies.
Institutional investors are increasing allocations to focused strategies, or strategies consisting of 50 or fewer securities. These strategies make up between 20% and 30% of total active equity assets among the 75 U.S.-based institutional investors and intermediary fund platforms participating in a recent Greenwich Associates study conducted in partnership with Fred Alger & Company, Inc. on focused strategies.
After more than a year of solid growth, these allocations are on track for continued expansion in 2018 and beyond, with nearly two-thirds of institutional investors in the study planning to increase allocations to focused strategies over the next 12-18 months. Over the same period, every one of the retail fund platforms in the study plans to maintain or increase their recommended allocations to focused strategies.
“Driving this growth is investors’ belief that the best way to create alpha is by allocating assets to managers that diverge from their benchmarks and place bets on their highest-conviction investments to drive outperformance,” says Davis Walmsley, Greenwich Associates Managing Director and coauthor of the new report, The Power of Focus: Looking for Alpha in a Sea of Beta.
Conviction Drives Excess Returns
Seventy-six percent of intermediary retail fund platforms believe focused strategies have a better chance than diversified strategies of delivering alpha. These intermediary fund platforms put their trust in focused strategies in large part because they believe that, in any active portfolio, excess returns are driven disproportionally by the portfolio manager’s highest-conviction holdings. Ninety percent believe these holdings contribute disproportionally to a strategy’s overall outperformance.
Many investors reject the notion that investing in focused strategies materially adds risk to their portfolios. Eighty-eight percent of the investors in the study believe that a portfolio of just 50 stocks can achieve the majority of the risk-reduction benefits generated by a diversified portfolio. Among intermediaries, that share reaches 95%.
“In fact, many investors believe that attempting to reduce the idiosyncratic risk within a focused portfolio defeats the purpose of adding these strategies in the first place,” says Sara Sikes, Greenwich Associates Principal and coauthor of the study. “These investors think risks can be better managed though smart and diligent portfolio construction that takes into account correlations with other portfolio assets—without sacrificing the strategy’s alpha potential.”