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.