Frequently Asked Questions - Litman Gregory Masters Funds Concept
Litman Gregory created the Litman Gregory Masters Funds with the objective of isolating the stock-picking skills of a group of highly regarded and experienced portfolio managers. To meet this objective, we designed the funds with both risk and return in mind, placing particular emphasis on the following factors:
- Only stock-pickers Litman Gregory believes to be exceptionally skilled are chosen to manage each fund’s sub-portfolios.
- Each stock-picker runs a very focused sub-portfolio of not more than 15 of his or her favorite stocks within each Litman Gregory Masters Fund. We believe that most stock pickers have an unusually high level of conviction in only a small number of stocks and that a portfolio limited to these stocks will, on average, outperform (their) more-diversified portfolios over a market cycle.
- While each individual manager’s portfolio is focused, we achieve broader diversification in several ways. With the Equity and International funds we include managers with differing investment styles and market-cap orientations. With the Smaller Companies Fund, much like Equity and International, the managers use different investment approaches though each focuses on the securities of smaller companies.
- Limiting the asset base of each fund is supportive of the Masters’ concept. Litman Gregory believes that excessive asset growth can result in diminished performance. We have committed to close each Litman Gregory Masters Fund to new shareholders at a level that we believe will preserve the managers’ ability to effectively implement the “select” concept.
We believe it is a combination of five factors:
- The skill of the sub-advisors;
- The mandate that each sub-advisor run a concentrated sub-portfolio of only their highest conviction ideas;
- The inherent diversification that comes from a multi-manager approach;
- Litman Gregory’s responsibility for due diligence, monitoring and overall operations of the funds; and,
- The willingness of Litman Gregory to limit assets to levels that preserve the managers’ ability to own only their highest-conviction names.
First, it is worth noting that we don’t believe that all stock pickers are able to add value through concentrated investing. We also don’t believe concentration will result in higher returns in all time periods. However, for skilled, high-conviction stock pickers, we believe there is the potential to deliver higher returns over the long run with a concentrated portfolio.
Over the years we’ve interviewed hundreds of stock pickers and have come to understand that most active managers are not equally confident in all the stocks they hold in a broadly diversified portfolio. Consequently, if we believe a particular stock picker can add value via active management, then we believe it is logical that the stock picker can add more value over the long run by concentrating on a smaller number of their highest conviction ideas.
There are three broad reasons why more managers don’t concentrate their portfolios to a greater degree. First, as we noted, not all managers have approaches that would benefit from concentration. For example, a top-down manager who seeks to identify industries or regions likely to perform well might want to own a larger number of names to ensure good representation in that area. Second, even managers who emphasize bottom-up company research may not feel comfortable with the risks entailed in owning a smaller number of names, so they add more names to reduce overall portfolio risk. Third, asset growth often requires managers to own more names and larger-cap names. As noted earlier, there is a fourth issue—stock pickers who are not skilled may not be able to add value through concentration. In fact, they may detract value by virtue of less diversification. The Masters’ concept addresses each of those issues. We only choose managers we believe are highly skilled and likely to benefit from concentration, we seek to achieve overall portfolio diversification by combining managers, and we limit assets.
We believe flexibility is important. Ideally, a stock picker should be able to efficiently buy and sell stocks at the prices they deem attractive. They should be able to do this without their own trading volume influencing the price of the stock being bought or sold. However, when an investment firm runs too much money it may take a long time to buy or sell a full position because the number of shares being bought or sold may make up many days of the stock’s average daily trading volume. The result is that the stock price could move against the buyer/seller during the lengthy transaction period or the buying or selling could itself move the stock price.
By keeping the individual asset levels of each sub-advisor relatively small Litman Gregory believes the Litman Gregory Masters Funds will have several advantages. Because Litman Gregory Masters Funds requires the sub-advisors to hold only their highest-conviction ideas, it is not unusual for a stock to be sold in a Litman Gregory Masters Funds portfolio at a time when it is still attractive enough to be a “hold” in the sub-advisor’s more-diversified portfolios. When this happens, Masters’ small asset base allows the advisor to sell the position quickly and with little market impact. On the buy side, in some cases sub-advisors have been able to buy holdings for Masters’ that they can not buy for other, larger funds they manage. Though this is not typical, several sub-advisors have been able to do this on occasion.