In the field of portfolio management, age old consensus presumes that concentration and volatility always go hand-in-hand. But is this really true?

Certainly, Seabird credits much of our clients’ outperformance to their willingness to hold slightly concentrated portfolios. But have we been just unwittingly taking on risk? The volatility data below would be at least a couple of significant data points defying that conclusion:

Seabird:                  4.62%
S&P Muni Index:  4.92%

Maybe even more pertinent is our clients’ Upside/Downside capture:

Seabird Upside Capture:             92.7%
Seabird Downside Capture:         8.4%
*Relative to S&P Municipal Bond Index benchmark

But are we just fooling ourselves with data to draw a desired conclusion? Have we slipped into the hole of confirmation bias? Or is there a logical reason why concentration could reduce volatility? Might there be other portfolio characteristics acting to reduce risk and volatility? We have identified 4 clear reasons our portfolios of 15-25 names behave unusually well:

  • Concentrating a portfolio puts a portfolio manager to the task of being extra vigilant vis-à-vis both credit and interest rate risk. Each position having added significance, each decision is treated accordingly: for us, the psychological pressure is unmistakable.
  • Concentrating a portfolio in 15-25 names gives a portfolio manager the time to do a truly deep dive into credit quality: something not at all feasible in a portfolio of 100+ names.
  • The vast majority of Municipal Bonds are extremely creditworthy. High-risk Muni bonds are a fringe rarity. The greater the expansion of a portfolio, the closer it tends to creep toward the fringe.
  • Our lightly constrained mandate is key to reducing interest rate risk. When portfolio managers have the latitude to invest a small portion of client assets in high quality, low duration non-core assets – such as cash or floating rate bonds – volatility may be reduced significantly.

We conclude that the willingness to defy an institutional norm – concentration – creates a sense of urgency with each investment decision that is largely absent in diversified portfolios. That urgency combined with clients’ willingness to adopt a style box defined by common sense – rather than institutional mandates – allows us to enjoy latitude which others don’t have; the latitude to avoid risk when and where we see it.