Concentrated Investing: The Wave of the Future?
Nick Elward Sr
SVP, Head of Institutional Product and Head of ETFs, Natixis Investment Managers
Over the last 50 years, diversification – investing in a large and varied number of stocks – has played a prominent role in portfolio construction. However, Vaughan Nelson Investment Management, an affiliate of Natixis Investment Managers, believes that over the next 50 years, investors will move toward more concentrated portfolios consisting of high-conviction, well-researched ideas. Why? Because evidence suggests that these companies have the ability to perform well for investors.1
A Focus on Best Ideas
Portfolio managers review countless data points and investment themes on a regular basis. Certainly, with all of the ideas they uncover, they could potentially invest in hundreds of interesting stocks. However, portfolio managers that choose only their top ideas for a concentrated portfolio do so by relying on a greater depth of research that can help ensure that stock selection is undertaken with strong conviction. For example, they can analyze company-specific dispersion of returns, as opposed to considering broad sector or industry analysis alone. This kind of concentrated investment style has the potential to lead to outperformance for investors. In fact, many portfolio managers’ top 10 or 20 ideas greatly outperform the rest of their portfolios.2
Adequate Diversification
A concentrated investment approach does not mean limiting a portfolio’s scope to just one or two stocks. Adequate diversification remains important – and achievable. Factor analysis can be used to help determine satisfactory portfolio diversification. Computer-aided factor analysis can help ensure the right amount of diversification with more accuracy than the old-fashioned approach of simply owning a large and varied number of stocks. This kind of factor analysis has the potential to more accurately predict how individual stocks may react to different market scenarios and therefore assist in more accurately gauging the potential for long-term risk.
Concentrating on Growth
Concentrated portfolios is a core tenet of Vaughan Nelson’s investment approach. For example, the?Natixis Vaughan Nelson Select ETF (VNSE)?generally holds about 30 stocks in a portfolio that is constructed using factor analysis and strict consideration of long-term growth potential and risk management. In recent history, achieving broad-based diversification was accepted as general practice in the investment universe. Nonetheless, investment managers like Vaughan Nelson may better represent the coming decades of portfolio construction, one in which factor analysis and deep research informs more rigorous “best idea” portfolio design that focuses on risk and long-term growth and more calibrated diversification.
1, 2?“Diversification versus Concentration . . . and the Winner is?” By Danny Yeung, Paolo Pellizzari, Ron Bird, Sazali Abidin
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Equity Securities Risk:?Equity securities are volatile and can decline significantly in response to broad market and economic conditions.?Non-Diversified Risk:?Non-diversified funds invest a greater portion of assets in fewer securities and therefore may be more vulnerable to adverse changes in the market.?Value Investing Risk: Value investing carries the risk that a security can continue to be undervalued by the market for long periods of time.?Predatory Trading Practices Risk: Although the Fund seeks to benefit from keeping its portfolio holdings information secret, market participants may attempt to use the Proxy Portfolio and related Proxy Portfolio Disclosures to identify the Fund's holdings and trading strategy. If successful, this could result in such market participants engaging in predatory trading practices that could harm the Fund and its shareholders.?Proxy Portfolio Structure Risk:?Unlike traditional ETFs that provide daily disclosure of their portfolio holdings, the Fund does not disclose the daily holdings of the Actual Portfolio. Instead, the Fund discloses a Proxy Portfolio that is designed to reflect the economic exposure and risk characteristics of the Fund's Actual Portfolio on any given trading day. Although the Proxy Portfolio and Proxy Portfolio Disclosures are intended to provide Authorized Participants and other market participants with enough information to allow them to engage in effective arbitrage transactions that will keep the market price of the Fund's shares trading at or close to the underlying NAV per share of the Fund, while at the same time enabling them to establish cost-effective hedging strategies to reduce risk, there is a risk that market prices will vary significantly from the underlying NAV of the Fund.?Authorized Participant Concentration Risk: Only an authorized participant ("Authorized Participant") may engage in creation or redemption transactions directly with the Fund. The Fund has a limited number of institutions that act as Authorized Participants, none of which are or will be obligated to engage in creation or redemption transactions. To the extent that these institutions exit the business or are unable to proceed with creation and/or redemption orders with respect to the Fund and no other Authorized Participant is able to step forward to create or redeem Creation Units, Fund shares may trade at a discount to NAV and possibly face trading halts and/or delisting. The Fund's novel structure may affect the number of entities willing to act as Authorized Participants, and this risk may be exacerbated during times of market stress.?Trading Issues Risk:?Trading in Fund shares on the NYSE Arca may be halted in certain circumstances. If 10% or more of the Fund's Actual Portfolio does not have readily available market quotations, the Fund will promptly request that the NYSE Arca halt trading in the Fund's shares. Such trading halts may have a greater impact on the Fund compared to other ETFs due to its lack of transparency.?Premium/Discount Risk:?The market value of the Fund's shares will fluctuate, in some cases materially, in response to changes in the Fund's NAV, the intraday value of the Fund's holdings, and the relative supply and demand for the Fund's shares on the exchange. There is a risk (which may increase during periods of market disruption or volatility) that market prices for Fund shares will vary significantly from the Fund's NAV. This risk may be greater for the Fund than for traditional ETFs that disclose their full portfolio holdings on a daily basis because the publication of the Proxy Portfolio does not provide the same level of transparency as the publication of the full portfolio by a fully transparent active ETF.
Before investing, consider the fund's investment objectives, risks, charges, and expenses. You may obtain a?prospectus or a summary prospectus?containing this and other information. Read it carefully.
Diversification does not guarantee a profit or protect against a loss.
RISKS
ETF General Risk:?Exchange-Traded Funds (ETFs) trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are not individually redeemable directly with the Fund, and are bought and sold on the secondary market at market price, which may be higher or lower than the ETF's net asset value (NAV). Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns.
Active ETF: Unlike typical exchange-traded funds, there are no indexes that the Fund attempts to track or replicate. Thus, the ability of the Fund to achieve its objectives will depend on the effectiveness of the portfolio manager. There is no assurance that the investment process will consistently lead to successful investing.
Fund is new with a limited operating history.
ALPS Distributors, Inc. is the distributor of the Natixis Vaughan Nelson Select ETF. Natixis Distribution, LLC is a marketing agent. ALPS Distributors, Inc. is not affiliated with Natixis Distribution, LLC.
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