The relentless growth of passive products and sophisticated smart-beta products have been putting pressure on active fund managers to show what value they add. High-conviction managers, with concentrated portfolios, aim to stand out from the pack by differentiating themselves from benchmark-hugging managers who claim to be active.
While the idea of relying on the skills of an experienced manager to pick a small number of high-quality companies is attractive, FSA has decided to find out how such managers perform, compared to those who manage larger portfolios.
Two groups of equity funds available for sale in Hong Kong and/or Singapore were selected for the research. One consists of China equity funds (specifically, Morningstar categories China equity, China equity-A Shares and Greater China equity).
There are 95 such funds, for which three-year performance data and the number of holdings in portfolios are available.
The other group consists of 88 Asia ex-Japan and Asia-Pacific ex-Japan funds, selected based on the same criteria.
Concentrated China funds
Among the China equity funds, 26 out of 95 had fewer than 40 listed holdings. Funds in this range had lower three-year alpha (average and median) than funds with more holdings. They also had a slightly higher average fee, although the median fee was the same as for other ranges. The percentage of these concentrated funds underperforming their indices was higher than more diversified peer products.
Chinese equity mutual funds
| Number of holdings | Number of funds | 3-yr alpha (average/median) | Percentage of underperformers | Average fee |
| less than 40 | 26 | -3.43 / -1.46 | 62 | 1.54 |
| 40 – 59 | 41 | 0.53 / -0.4 | 54 | 1.41 |
| 60 – 79 | 11 | 1.17 / 0.12 | 36 | 1.32 |
| 80 – 99 | 10 | -0.86 / -0.04 | 50 | 1.47 |
| 100 or more | 7 | -0.37 / 1.90 | 43 | 1.36 |
Data: Morningstar, 30 November 2017. Average alpha for the 95 Chinese funds as a whole is -0.69, median alpha is -0.40
Funds with 60-79 holdings had the best average alpha, the lowest share of underperformers and the lowest average fees.
Asia-Pac ex-Japan
Among the Asia-Pacific ex-Japan funds, only three had fewer than 40 holdings, so we extended the definition of concentrated funds to those with fewer than 50.
For this set, we made a similar observation as for the Chinese equity funds. More concentration means a lower three-year average alpha and a higher percentage of underperforming funds.
Asia-Pacific ex-Japan equity funds
| Number of holdings | Number of funds | 3-yr alpha (average/median) | Percentage of underperformers | Average fee |
| less than 50 | 17 | -1.47 / -1.67 | 76 | 1.24 |
| 50 – 69 | 31 | 0.22 / 0.36 | 45 | 1.27 |
| 70 – 89 | 17 | 0.61 / 0.03 | 47 | 1.39 |
| 90 – 119 | 11 | 0.35 / -0.06 | 55 | 1.40 |
| 120 or more | 12 | 0.63 / -0.35 | 67 | 1.20 |
Data: Morningstar, 30 November 2017. Average alpha for the 88 Apac funds as a whole is 0.04, median alpha is -0.24
Among the Asia-Pacific ex-Japan funds, those with a moderate number of holdings (70-89) and those with more than 120 had the highest average alpha. Those between 50 and 89 holdings had the lowest share of underperforming funds, while highly-diversified ones had the lowest average fees.
Conclusion
Although in principle high-conviction portfolios should outperform, since managers are able to limit their choices to the absolute best prospects they can find, in practice delivering alpha using such an approach is difficult.
We did not compare these results to those in developed markets (a task for another day), but venture to speculate that stockpicking is more difficult in emerging markets, due to less analyst coverage and poorer transparency. Judging future earnings growth and intangibles such as management intent is that much more difficult.
In particular, it is difficult to predict the effects of policy on sectors and businesses in China, where it is a major factor. The two funds in the China equity sample that specifically aim to benefit from policy, the CCB International China Policy Driven Fund (21 holdings) and the Shenyin Wanguo China Policy Focus A Fund (30 holdings) had the lowest alphas: -15.42 and -13.62, respectively.
