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Boohoo, Wirecard, and the fund concentration game

When big bets go wrong
July 13, 2020

The scandal surrounding Boohoo (BOO) has quickly morphed into a reputational firestorm for ESG funds, with the managers of ASI UK Ethical Equity and Premier Ethical among those who counted the stock as a top 10 holding. But the damage to these funds’ returns should at least prove relatively limited in the longer run: each had a position of less than 5 per cent at the end of May.

The same reassurances do not apply to all professional investors. Merian UK Mid Cap, a fund run by Richard Watts, had 11.7 per cent of its assets in Boohoo on 30 June, leaving it particularly vulnerable to the sell-off that followed. Luke Kerr, a colleague of Mr Watts, had a 10.6 per cent position in the company via the Merian UK Dynamic Equity fund.

Much as it has implications for the application of ESG investment criteria, the Boohoo story also serves as a reminder that portfolios with concentrated positions are heavily exposed to stock-specific problems.

The incident has echoes of another company crisis currently reverberating through the fund management space. Alexander Darwall, the renowned manager of the European Opportunities Trust (JEO), had a weighting of more than 10 per cent in Wirecard (GER:WDI) when the payment provider's own scandal sent its shares tumbling on 18 June.

 

Money where your mouth is

A degree of portfolio concentration is generally not a bad thing: fund managers, like private investors, need weight behind their best ideas to really benefit if a thesis plays out, while limiting their number of holdings can be a good way to properly target resources. In some cases, fund managers need to put big chunks of money behind certain stocks simply to stay broadly in line with their underlying market. Many UK equity income managers have long been reliant on the same handful of FTSE 100 stocks for the lion’s share of dividend payments, while US equity managers tend to allocate heavily to names such as Amazon (US:AMZN) because of its major presence in the S&P 500 as much as its exceptional returns.

Some have benefited handsomely from a high-conviction approach: every single top 10 holding in Lindsell Train UK Equity represented at least 6 per cent of assets at the end of May, for example. The Merian funds caught out by the Boohoo sell-off have, themselves, tended to perform strongly versus their peers. And the five open-ended funds with the best sterling returns from the decade to 10 July all had at least two positions of 5 per cent or more.

 

FundNumber of holdings bigger than 5%
Morgan Stanley US Growth2
Legg Mason IF Japan Equity5
Baillie Gifford American4
Polar Capital Global Technology2
Morgan Stanley US Advantage4
  
Source: Latest provider factsheets 

 

Mitigating the risk

While concentration is an intrinsic characteristic for certain funds, individual bets approaching the 10 per cent mark can be a warning sign, especially if the company concerned faces unanswered questions. Mr Darwall stuck to his Wirecard position even as noise grew about suspected financial irregularities, only ditching the shares when the scale of the problem became clear on 18 June. A statement from Merian owner Jupiter suggests that the likes of Mr Watts are sticking with Boohoo for now following "strong assurances" from company management.

European regulations prevent many open-ended fund managers from going entirely overboard with their biggest bets. The 5:10:40 Ucits diversification rule means an individual stock cannot make up more than 10 per cent of assets, while all holdings that make up 5 per cent or more of the portfolio cannot, in total, add up to more than 40 per cent of assets. Fund managers who fall foul of these rules as a result of share price moves must bring the portfolio back into line "as soon as reasonably practicable" and, in any event, within six months.

But not all funds are subject to such restrictions. Some concentrated open-ended funds, such as Lindsell Train UK Equity, are not governed by Ucits rules. Investment trusts will set their own parameters to an extent.

Notably, the Ucits diversification rules are relaxed for passives, sometimes resulting in substantial positions. In the case of the iShares S&P 500 Communication Sector UCITS ETF (IUCM), the inclusion of tech giants Facebook (US:FB) and Google-owner Alphabet (US:GOOGL) in the relevant index means they recently represented around 19 and 30 per cent of assets, respectively.