Diversification – it’s only good in moderation

Just selecting good funds doesn’t do it. Having the right mix to ensure proper diversification is at least as important. But can you actually own too many funds?

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PA Europe

“Overdiversification does not exist,” according to Thomas Romig, who is used to managing large portfolios as head of multi-asset at Assenagon AM in Frankfurt.

“If active equity managers can have positions of 2 to 3% to a stock, why couldn’t fund-of-fund managers allocate a similar percentage to a single fund?,” Romig argued during a panel debate with two peers at the recent Expert Investor Alternative Ucits Congress in Noordwijk, the Netherlands.

For David Karni (pictured), head of fund selection at BCC Risparmio & Previdenza in Milan, overdiversification is not much of an issue either. “For example, we have two long/short European equity funds, but that’s not a problem for me as these are both very different funds. One has returned 3% year-to-date, while another has made 11%. As long as they achieve their goals, I’m happy to own both.”

Avoid overlap

But what you should of course avoid is owning funds that have too much overlap. Doing that risks monitoring costs outweighing diversification benefits.

In an ideal world, the number of funds investors can hold in their portfolios is endless, as long as ‘twin funds’ with similar investment philosophies can be avoided. But in practice, it’s only possible to adequately monitor a select number of funds, notes Vincent Batailler, founder of Paris-based Iodda Advisors.

Know your manager

“Before ’08 we had a concentrated portfolio of about 15-20 funds, but following the crisis risk management asked us to diversify our holdings, and include up to 40 funds,” he said.

“Well, that’s not manageable. It’s very difficult to monitor 30 to 40 managers, and eventually your performance won’t be great,” Batailler (pictured) added. Especially in the alternatives bucket, you shouldn’t select more than 10 managers, he believes.

Romig agrees it’s paramount to know a manager personally. And only for that reason, the number of managers you can own is limited. “We operate a fund-of-funds with 12 to 18 strategies,” he says.

“What’s important is that a manager really is passionate about the theme he invests in,” Romig asserts.

Karni adds: “It’s crucial to know your manager, especially in the alternative space because these managers are more star manager types. You have to understand how they are likely to react to situations happening in the market.”