Image Credit: Christophe Vorlet
By Jason Zweig | May 11, 2016 9:23 am ET
Go big or go home.
If you want to settle for matching the market, buy an index fund that will buy every stock or bond in the basket. But if you want to try doing better, aim big: Buy a fund that makes a few huge bets that look nothing like the market.
That used to be the message among the stock pickers running actively managed portfolios in the age of the index fund. But those voices have grown quieter lately, especially after many leading mutual funds and hedge funds got pounded as their top holding Valeant Pharmaceuticals International fell 87% over the past year.
To see the promise and perils of going big in their purest form, consider Putnam Capital Spectrum Fund, at $6.1 billion the largest mutual fund run by Putnam Investments of Boston, and its $1.8 billion sibling, Putnam Equity Spectrum Fund.
Launched in May 2009 and managed by investing veteran David Glancy, they performed extraordinarily well in the wake of the financial crisis. Capital Spectrum returned an average of 22.1% annually from the beginning of 2010 through the end of 2013, while Equity Spectrum averaged 24.8% over the same period. The S&P 500, by comparison, returned 15.9% annually.
Before that, Mr. Glancy ran a similar portfolio, Fidelity Leveraged Company Stock Fund, which generally performed well. In 2008, after he left Fidelity, the fund lost a bloodcurdling 54.5%, showing that such portfolios, focused on a few companies with lots of debt, pay off much of the time but can be intensely risky, too.
And seldom have fund managers taken focusing on a few companies quite this far.
By comparison, the average U.S. stock fund with more than $1 billion has only 22% of assets in its top 10 holdings, says Morningstar, the investment-research firm. The 10 biggest stocks in the S&P 500 index amount to 17.5% of the benchmark.
What’s more, the two Putnam funds hold many stocks in tandem. Capital Spectrum has 21.3% of its assets in Dish Network and 13% in Jazz Pharmaceuticals, as well as 6.8% in EchoStar. Equity Spectrum has 25.6% in Dish, 15.8% in Jazz and 9.4% in EchoStar.
EchoStar was spun off from Dish in 2008, and the chairman of both companies, Charlie Ergen, owns a majority of their voting shares.
The Spectrum funds, all by themselves, own one in every six of Dish’s Class A shares, one in every seven of Jazz’s ordinary shares and nearly one in every three of EchoStar’s Class A shares.
If they ever need to sell these stocks, who will buy them in such quantity?
Walter Donovan, Putnam’s chief investment officer, says the two funds are “very clearly” marketed as “a concentrated strategy.” The prospectus warns that each fund may hold far fewer investments than normal, which “can increase the fund’s vulnerability” to risk. They are sold exclusively through financial advisers, who are “very educated and sophisticated,” says Mr. Donovan.
Old-timers on Wall Street like to say, “Liquidity is only there when you don’t need it.” It’s easy to sell in a rising market, but if you suddenly need to get out, fair-weather buyers may disappear and selling at a decent price can become hard in a hurry.
“We do monitor the issues as to how these funds are composed and the liquidity of the funds, and we’re in a good place right now,” says Mr. Donovan. “These funds take a long-term view of their holdings, and we’re comfortable with it.”
The two funds, like all of Putnam’s portfolios, “come under daily, rigorous risk controls,” says Mr. Donovan. “These are fundamental, concentrated funds driven by the performance of the largest holdings.”
Meanwhile, Kerrisdale Capital, a hedge-fund manager in New York, is selling Dish’s shares short, a bet that the stock will fall. Kerrisdale has raised $100 million for that bet, says a person familiar with the matter. Sahm Adrangi, Kerrisdale’s founder, says Dish is overvalued by 60% to 80%.
“We will continue to manage the business for the long-term benefit of our shareholders as we have done over the last 35 years,” says Dish spokesman Robert Toevs in a statement.
Investors chased the Spectrum funds’ performance when it was hot. Assets, only $391 million in both funds at the end of 2010, boomed to a combined $15.3 billion early last year. In 2014 alone, investors added $5 billion.
More recently, performance has faltered; last year, Capital Spectrum fell 9% and Equity Spectrum 14%. Right on cue, over the 12 months ending March 31, investors pulled $5 billion out of the two funds, estimates Morningstar.
So the funds have had to draw down some of their cash to meet redemptions from departing investors. Partly as a result, the two funds now have the highest concentration they’ve ever had in their top 10 holdings, according to Morningstar.
But even some of their smallest positions are concentrated. Combined, the Spectrum funds own big stakes in several tiny companies, including nearly 7% of HC2 Holdings (whose total market capitalization is $157 million), 8% of Ocwen Financial (total market cap, $268 million), 10% of GenMark Diagnostics ($240 million), nearly 11% of UCP ($64 million) and 19% of Staar Surgical ($290 million).
All told, those stocks are a minuscule fraction of the funds’ holdings — but the Spectrum funds are among the biggest owners of each of those companies.
Don’t put all your eggs in one basket, says the old proverb. Andrew Carnegie and Mark Twain famously rewrote that to say, “Put all your eggs in one basket — and watch that basket.”
Putnam’s bets may yet work out, but for its investors the biggest risk of all might be taking their eyes off that basket.
Source: The Wall Street Journal