This reduces the harm that any single stock can do to the portfolio, but the reverse is also true – the outperformance of any one company has less effect on the fund.
This means that it takes a great deal of stockpicking skill to produce good returns from a broader portfolio.
Here are five funds that have managed to give investors the best of both worlds in terms of diversification and outperformance.
Marlborough UK Micro Cap Growth
FE Alpha Manager Giles Hargreave’s £145m portfolio contains a massive 224 holdings in companies with a market capitalisation of £100m or less.
Despite this, it has been one of the leading funds in the IMA UK Smaller Companies sector over three and five years, making 89.09 and 108.37 per cent over these periods respectively.
Performance of fund vs sector over 5yrs
Source: FE Analytics
Despite operating in the volatile micro-cap environment, Hargeave has managed to outperform the IMA UK Smaller Companies sector in the two most recent years when markets fell – 2008 and 2011.
Hargreave, who has worked with co-manager Guy Feld for little over a year, has a low turnover rate on the five crown-rated portfolio of 33.85 per cent, reflecting his conviction in the individual companies he holds.
He keeps each holding in his fund down to a maximum size of 2.5 to 3 per cent.
His style is in sharp contrast to some other managers in the sector who are equally well-regarded.
FE Alpha Manager Harry Nimmo, for example, holds just 55 stocks in his smaller companies fund and "runs his winners", refusing to sell out of a stock even when it has grown to the point where it can no longer be considered a smaller company.
The Marlborough fund requires a minimum initial investment of £1,000 and has ongoing charges of 1.54 per cent.
Aberdeen Global Asian Smaller Companies
This $4.4bn fund, domiciled in Luxembourg, limits itself to a maximum of 2.9 per cent in any one holding.
Its top-10 holdings make up only 26.57 per cent, and the fund is significantly less concentrated than the average IMA Asia Pacific ex Japan fund.
It is also the best-performing fund in that sector over six months and one, three and five years, according to FE Analytics.
Aberdeen's Asian equities team – headed up by FE Alpha Manager Hugh Young – has managed to harness the extra growth of smaller companies despite holding a less concentrated portfolio.
The fund has made 164.28 per cent over the last five years while the sector has made 54.98 per cent, according to data from FE Analytics.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
The fund is available with a minimum initial investment of $1,500 in sterling and has ongoing charges of 1.99 per cent. It has five FE Crowns.
PFS Chelverton UK Equity Income
This £62m fund has had some success in the IMA Equity Income sector through investing in smaller and mid cap companies, including those listed on AIM.
It is much less concentrated than the average fund in the sector, with just 23.01 per cent in the top-10 and no single position making up more than 2 per cent of the portfolio.
In comparison, Neil Woodford’s £12.8bn Invesco Perpetual High Income fund has 56.75 per cent in its top-10.
The Chelverton fund, which has five FE Crowns, is currently yielding 4.66 per cent, according to data from FE Analytics, putting it above the sector average.
It has delivered the third-best total returns in its sector over five years and the second-best over three.
Over the latter period it has made 72.32 per cent while the sector has made just 33.57 per cent.
Performance of fund vs sector and index over 3yrs
Source: FE Analytics
The fund requires a minimum initial investment of £1,000 and has ongoing charges of 1.88 per cent.
M&G Recovery
Tom Dobell’s £7.5bn portfolio has a heavy weighting to the top-five holdings but is less concentrated further down the portfolio.
The manager has 25.35 per cent in his top-five but just 39.55 per cent in his top-10, according to data from FE Analytics.
The top-20 holdings make up just 57.15 per cent of the fund, which has 99 holdings in all.
Dobell invests across the full range of the market, with a high weighting towards both large and small caps.
It has struggled since the financial crisis, with performance over three years putting it in the bottom quartile of the IMA UK All Companies sector.
In that time is has made 20.98 per cent while the average fund in the sector has made 31.39 per cent.
Performance of fund vs sector over 3yrs
Source: FE Analytics
The fund is still in the top quartile over 10 years, however.
The minimum initial investment is £500 and the ongoing charges are 1.65 per cent.
Invesco Perpetual Global Smaller Companies
This £436m fund is managed on a team basis, with analysts given responsibility for certain regions and asked to find stock ideas.
The team decides centrally how much to allocate to each area of the world before selecting the best ideas of each of the regional divisions to complete the portfolio.
It is one of the least concentrated in the entire IMA universe, holding between 300 and 400 stocks at any one time.
According to FE Analytics data it currently has only 7.88 per cent in its top-10 holdings.
This team approach has worked well for the fund, which is a top-decile performer in the IMA Global sector over three, five and 10 years.
Over the longer time period it has returned 308.37 per cent while the MSCI World Small Cap index has made 252.54 per cent.
The fund is available with a minimum initial investment of £500 and has ongoing charges of 1.72 per cent.