In order to improve performance, advocates of active management have begun to argue that managers should focus exclusively on their best ideas, holding more concentrated portfolios of securities in which they have the highest confidence. In contrast, we argue that if it becomes popular, such “high conviction” investing is likely to:

  • Increase risk
  • Make manager skill harder to detect
  • Raise asset owners’ costs, and
  • Reduce the number of outperforming funds

These arguments apply even if we accept that security selection skill is prevalent among active managers. Concentration only makes sense if managers have a particular type of skill, and this skill must be intrinsically rare.

Source: http://us.spindices.com/documents/research/research-fooled-by-conviction.pdf

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