The big-name funds make unsuitable diversifiers, our figures suggest, with many of them holding a significant number of large positions in common.
The Invesco Perpetual Income, Artemis Income, Threadneedle UK Equity Income, Jupiter Income and Schroder Income funds are all very popular with investors but all also have a similar top ten holdings.
The £1.5bn Schroder Income, managed by Kevin Murphy and Nick Kirrage, and the £2bn Jupiter Income fund, managed by Ben Whitmore have six of the same stocks as top ten holdings in their respective portfolios.
They both have: AstraZeneca, GlaxoSmithKline, BP, BAE, Vodafone and Hewlett Packard. The £7.8bn Invesco Perpetual Income fund, managed by FE Alpha Manager Mark Barnett, has four of these stocks.
The £3bn Threadneedle UK Equity Income fund, run by another FE Alpha Manger Leigh Harrison, and the £6.7bn Artemis Income fund also have six of the same top ten holdings in their respective portfolios.
These are AstraZeneca, GlaxoSmithKline, Imperial Tobacco, Royal Dutch Shell, BT and Legal & General.
Paul Warner, managing director of Minerva Fund Management, says duplicating your exposure to the same area or stocks is a major problem when building a portfolio.
“It could take away your opportunity to diversify away elsewhere. Also, being in more than one of these funds you are not getting any of the potential benefit of the long term growth prospects of being in small or mid caps.”
“When I construct equity income portfolios I usually include some of the funds that are more mid and small cap orientated to act as a balance,” he said.
“However, it is not a risk to the extent that some conceive it to be because it may sound like you are really concentrating your portfolio when all funds have the same holdings but you are not necessarily.”
“When you hold more and more stocks the incremental increase in risk and reward starts to tail off very quickly.”
“But these funds do tend to be the big income producers in the FTSE 100. From a relative point of view you could say the same thing about holding a tracker, but then again you would get a lot of the rubbish.”
Net inflows into the IMA UK Equity Income reached their highest ever monthly level in April 2014, at £500m, with much of it headed towards several well-known and already huge funds.
In fact, the 10 largest funds in the sector – out of 93 – make up more than half of the total £60bn size of the sector.
A potential problem arises if these funds start to look similar in their larger holdings, due to a narrower pool of suitable stocks given the amount of money that need to be invested.
If these companies experience problems or shocks, this could lead to dangerous risks for the sector as investors rush to withdraw and reallocate money.
A fund’s top ten holdings usually constitute at least 35 per cent of its total portfolio and often more than 50 per cent.
One of the most pertinent stock examples is GlaxoSmithKline which according to FE Analytics is held as a top ten holding by 71 out of 91 funds in the sector, with 33 holding more than 5 per cent of their portfolio in the stock.
Another good example is AstraZeneca. It is held as a top 10 holding by 47 out of 91 funds in the sector, with 13 funds holding more than 5 per cent of their portfolio in the stock.
Eight of the largest and most popular funds: Invesco Perpetual Income, Artemis Income, Threadneedle UK Equity Income, JOHCM Income, Newton Higher Income, Trojan Income, Jupiter Income, Schroder Income, Invesco Perpetual High Income – which recently moved into the UK All Companies Sector – all hold AstraZeneca in their top holdings. All of these funds also hold GlaxoSmithKline in their top five holdings.”
Performance of stocks over 3yrs
Source: FE Analytics
Five of these hold the stock as their largest holding, representing 7.5 per cent to 8.5 per cent of their portfolios.
Of the other four funds, three all hold another popular stock – Royal Dutch Shell – as their largest holding. Other widely held stocks include Vodafone, HSBC and BAE.
BAE’s share price was recently hit by its issuance of a profit warning after it warned that a decline in US defence spending could bring about a 10 per cent fall in profits.
Despite some of the similarity of the nine popular funds there is a reasonable dispersion in performance. It is important to remember that these funds will have bought in and out of these stocks at different times and therefore will see varying amounts of total return. They will also have varying charges.
Over just five months the funds have returned between 1.89 per cent and 6.77 per cent, making the dispersion more than three times between the lowest and the highest.
Performance of funds and sector in 2014
Source: FE Analytics
Over three years however; the dispersion has fallen with returns ranging from 32 per cent to 52 per cent, less than half the difference between the lowest and the highest.
Performance of funds and sector over 3yrs
Source: FE Analytics
Despite a narrower this is a considerable difference from a total return basis.
Warner says there may be just enough difference between similar funds to make case for holding more than one.
“For example one of the managers could do something really silly or leave.”
However, Warner says it is important to check a fund’s top ten holdings before buying it to check for overlap with other holdings.
Funds are currently not required to report more than their top ten holdings, so the degree of convergence of their investments is potentially even higher.
