This news service spoke to a UK-based firm, Blue Ocean Investment Partners, which believes that concentrated portfolios, when managed correctly, should hold as few as 15 stocks, or even a smaller basket.

The term “concentrated portfolio” gets thrown about a fair bit in the investment world. This publication has noted that the number of stocks in a fund can be as high as 50 in some cases. It was therefore refreshing to talk to a wealth manager holding as few as 15 companies’ shares.

As far as Ted Holmes, founder of Blue Ocean Investment Partners, is concerned, pursuing “Alpha” does require a tight selection of stocks for an actively-managed portfolio to be worthy of the name. 

With a career of more than 20 years at UBS Asset Management in London and Chicago, culminating as European head of equities, Holmes has seen how the big players in the wealth space manage stocks. He respects and values his time with such firms – but he decided a few years ago that he wanted to take a different path. So, from 2018 he built Blue Ocean. 

“I had also always had the idea that I wanted to do something for myself. So I decided to leave UBS and to do something for myself and create something. I then basically spent the next several months analysing all of my career; all of the primary work that I had done myself, understanding where I added a lot of value, what did I enjoy, talking to lots of people, reading all of the books that I had been meaning to read and never seemed to find time to do,” Holmes told WealthBriefing in an interview.

“Then I basically wrote letters to myself and consolidated that all down. The generation of the Blue Ocean strategy kind of came out of all that analysis and that thought process. Blue Ocean…is a place where I get to focus on doing what I do really well and have demonstrated over 20 years of primary work, adding a lot of value. It is what I also enjoy. It will allow me and my investors to compound their own investments at I think a higher rate of return than the ones you can get on the market,” he said. 

“Knowing my own limitations, and how many targets I would be happy to locate, I settled in on this highly concentrated strategy of five to 15 names. Now that also necessitated some other parts of the process which were, ‘well if we are only going to hold five to 15 names, any one of them, if they blow up, can cause a huge hole in your performance’. So I spent a lot of time thinking about all of the places where I’d seen people lose money over the 20 years and then put in my process to make sure that I identified and eliminated those things from the target group. So that helps me in my targeting of the universe,” he said. 

As explained in an April update from the firm, Blue Ocean concentrates on companies with market capitalisations of between $1 billion and $10 billion. Firms smaller than $1 billion in market cap are not mature enough to evaluate in the firm’s process and companies above $10 billion receive more market attention, which can blunt returns. Holmes said this sort of corridor was where he generated the highest return to capital from his previous career. He also focuses on companies which are growing at a rate of more than 15 per cent because he thinks that the market misprices long-term growth and the operating margin leverage potential from this growth. 

Another filter is to go for less well-known firms, such as those covered by fewer than 25 analysts. 

A further metric is that Blue Ocean restricts its universe to companies with a minimum average daily volume of $10 million to ensure sufficient liquidity. Other filters include investability (ethical, social and environmental red flags). The firm also doesn’t like emerging market-focused companies because they have different governance and regulatory systems, and it is difficult to get hold of timely information. 

Show me the receipts
So how has Blue Ocean done in its first three years? 

Since inception, net of fee performance is a 122 per cent gain versus the S&P 500’s 57 per cent gain, the firm said in its April note. This result annualises at 30 per cent per annum versus 16 per cent for the S&P 500. Year-to-date, the strategy has, however, lagged the S&P 500, down 2.5 per cent versus the S&P’s 11.3 per cent gain. “Relative to the strong outperformance in 2020, we view this giveback as the natural ebb and flow of the market, which was discussed in the March newsletter,” the firm said. 

Some ebbs and flows of performance are part of the investment game, but the direction of travel is what counts for Holmes and his colleagues. 

“The basics of what I am doing is that this is what I love doing. I like sitting down every day and finding these really interesting companies. I know that most people, if they want data on the equities, they go to a UBS or one of the big shops and you’ll get their standard product, which is a pretty broad product and they will give you that market data, but the way I think about this is more of a satellite structure to give you that added Alpha,” he said.

“If you are a trustee and you can just increase your returns by just 1 per cent or 2 per cent in your strategic asset allocation, that’s a huge difference to what you can achieve for the asset owners themselves. So that’s what I thought about, that’s where I can add value. Not as a core strategy but as a satellite that you add on to your other core strategies and the bigger money managers that are out there,” Holmes said. 

Family office perspective
Family offices are natural clients for the fund, Holmes said. 

“Our core market is, we think, the family office space. Within the family office and the high net worth space is really the [key] area. Eventually, when we get more scale, we will be looking hopefully at a few endowments and foundations, but one of the key things for me is that there is really good alignment,” he said. 

“I want all of the investors, when I think about investing in equities, I think you have to have a minimum horizon of five years, although it's better if you have a 10-year horizon, because the markets are very volatile and you just never know what’s going to happen. You need that time to make up for any kind of market volatility and losses. I think that that is especially the case for a strategy like this so I need investors to think about the long term, I think about the long term and I need my investors to as well,” he said. 

WealthBriefing asked Holmes how he spends his time when Blue Ocean can hold as few as 10 stocks. 

“Once something is in the portfolio I don’t spend that much time on it because the way that I think about the companies is on a long-term basis. So, as an example of that, during all of 2020 with all of the big COVID movements in the markets…my estimates for the long-term values of the companies that we held did not move at all. Maybe very, very slightly but in total not at all,” he said.

“The reason for that is, in my estimation, it is just an adjustment, in the very near term, but it didn’t impact where the companies will be in 10 years. Because of the way that I think about the value of the companies, it really is where you think it’s going to be on a 10-year basis and I didn’t think this would make much of a difference at all. What I do is I ignore those things and I focus on the long term, but I let the market price tell me when it's actually a good time to buy a company,” he said. 

Controlled diet
“No position can be bigger than 12.5 per cent of the portfolio, and that’s not when I put it in, that’s at any point in time. They normally go in between 5 per cent and 9 per cent and when it gets to 12.5 per cent, I automatically have to pull it back. I also keep track of how much capital I have deployed into a name and on a net basis I cannot put more than 12.5 per cent of capital into a name either. These are the two ways that we try to control the single name risk exposure because it is so concentrated,” he said. (Another aspect is that Blue Ocean doesn’t take a short position or use leverage, or try to add yield via options and futures.)

“Everything that I have done with the portfolio construction and with the individual company selection is to say ‘this is where I think this company will be in 10 years’ and ‘what are the things that would stop me from being able to get there?'” Holmes said.

“One of the key things that we are looking at is the ESG [environment, society, and governance] factors and the ethics of the company itself. I have a view, there are two reasons [why] we do that. One is because it’s such a concentrated portfolio. I don’t want to support companies that hurt people or hurt the planet. If I am only going to hold five to 15 companies, why would I want to hold one that’s bad for the world?” he said. “The other reason, which is more practical, is that if you think of these companies on a long-term basis those are massive headwinds and if there is one thing that I am very aware of it's that if you have massive headwinds they may not hurt you in the short term but over the long term they are definitely going to cause lots of problems for you and your long-term performance.”