Most fund managers have their remuneration tied to how they perform relative to an index. Underperformance is tied to outflows in funds which limits the management fees they collect. Enter closet indexing. An approach where the managers avoid deviating too far from the index or their peers.

Furthering the temptation to stay relatively closely aligned to an index is the fund mandate or rules that govern how a fund invests. These mandates must be followed to ensure that investors in the fund are fully aware of what they are getting into when they invest. They also allow investors to match a fund to a specific exposure they are trying to achieve in their portfolio.

These two factors mean it is rare for a fund manager to have the full discretion to invest in their convictions. We have selected three funds awarded a gold medallist rating* by Morningstar’s Manager research team that have outsized top holdings.

These high conviction holdings deviate significantly from the index and their benchmarks, indicating bullish sentiments from our gold medallist fund managers.

We explore how these outsized positions stack up against our equity analysts’ research.

Hyperion Small Growth Companies—WiseTech Global Ltd—12.1% (as at May 31)

It’s all in the name—this strategy is for investors that seek growth style for small caps exposure. Our Manager Research Director, Michael Malseed, notes that the strategy has a strong growth bias and the portfolio can look expensive on near-term price/earnings valuation metrics. However, the team behind the strategy have a key skill set that lies in identifying businesses that have genuine long-term competitive advantages.

We see an active share measure of 92.88 for this strategy, showing that the team are actively deviating from their benchmark. This measures the similarity of the equity holdings of a fund and its benchmark. An active share score of 0 indicates that the equity portion of a fund and its benchmark are the same in both holdings and allocation. An active share score of 100 indicates that the equity portion of the fund and its benchmark have no common holdings. 

Their largest holding is WiseTech Global (ASX:WTC) making up 12.10% of a 21 security portfolio. WiseTech’s long term strategy centres around becoming the operating system for the logistics industry. It’s currently a 3-star stock, trading within a range we consider fairly valued (Fair Value of $90).

Our equity analyst, Roy Van Keulen, explains the strengths of Wisetech, and why it is a ‘kingmaker’. Ultimately, our analysts are in agreement with Hyperion that it is a quality company with strong growth prospects and sustainable competitive advantages against rivals, awarding it a narrow moat.

Greencape High Conviction—CSL Limited—10.63% (as at February 28th)

Greencape focuses on fundamental research in this high conviction strategy that hovers around 40 stocks. Although this is an Australian Equity strategy, the fund mandate allows for a 10% allocation to listed offshore companies (generally only half that amount is allotted). Manager research analyst Chris Tate notes that the firm has a track record of long-term discipline in managing capacity and index outperformance.

Their active share sits at 52.92, and CSL (ASX: CSL) makes up 10.63% of their concentrated portfolio. Following in Greencape’s footsteps, CSL was one of the most bought stocks by Morningstar Investor subscribers in June, indicating the broader market’s conviction in the future of this plasma therapy company.

CSL is currently a three-star stock, trading within a range that we consider fairly valued. CSL is one of three tier one plasma therapy companies that benefit from an oligopoly in a highly consolidated market. All the players are vertically integrated as plasma sourcing is a key constraint in production. The plasma sourcing market is currently in short supply, however, CSL is well positioned having invested significantly in plasma collection centres, owning roughly 30% of collection centres globally.

We award CSL a narrow moat rating based on the cost advantage afforded by its large-scale plasma collection and fractionation (this is where the various components of blood plasma are separated). CSL also possesses intangible assets based on the intellectual capital in its existing products and the proven success of its R&D efforts over time. The industry has high barriers to entry as plasma fractionation has long lead times, taking approximately seven years to be built and approved. Fractionation is also a complex process that requires significant expertise and scale to be performed cost-effectively.

Lazard Select Australian Equity—QBE Insurance—10.26% (as at March 31st)

Lazard’s Select Australian Equity offering is a concentrated value approach that our analysts think will suit investors with a long mindset and a stomach for higher volatility. It is run by three fund managers that have a long history of working together. The portfolio is concentrated—between 15-20 stocks with a strong value style tilt.

Due to the concentration of the strategy and the style and investment approach, it has an uneven return profile that requires an iron stomach. The ability to weather through his has rewarded investors in the past. It has an active share of 80.25.

Their largest holding is QBE Insurance Group Ltd (ASX: QBE), making up 10.26% of the portfolio. QBE is an international property and casualty insurance company, with 25% of annual premiums written in its home region of Australia and New Zealand.

We currently see it as a two star stock, overvalued at a 21% premium (Fair Value of $13). It does not have an economic moat as insurance is a fiercely competitive industry with commodity like premiums. Insurance customers won’t pay a sizable premium for brand, and the products are replicable—cost is the major differentiator.

QBE has tried its hand at global growth via acquisition, and the cost synergies and scale benefits did not materialise. The strategy has shifted to the core—cutting costs and tightening underwriting standards in the business which has led to a strengthened balance sheet.

Our analyst Nathan Zaia believes that a continuation of this strategy will modestly improve QBE’s performance over the next five years.

Nathan also notes that the performance of investment markets brings another element of volatility to earnings. QBE manages a sizable investment portfolio of about USD 28 billion as of Dec. 31, 2022, being both policyholder and shareholder funds. Around 90% is held in cash and fixed-interest investments, with the remainder spread across equities and alternatives. Consequently, the group's profitability is at risk from changes in interest rates, credit spreads, and—to a lesser extent—equity markets. We expect returns to remain suppressed in the short-term but will gradually recover as global cash rates normalise.