A couple of core assumptions usually lurk behind the ongoing active vs. passive investment debate:
Few market followers allow for the possibility that an active strategy can encompass a large number of securities.
And yet, logic says “why not?”
Why can’t a broadly diversified portfolio be managed in an active way?
We’ve long answered that it can.
Behind a disciplined security selection process and an equally rigorous portfolio monitoring process, our Growth Fund regularly holds 170-200 stocks:
As we have refined our approach over the years, we’ve found that many investors view our Growth Fund as a core portfolio position—one that offers the benefits of our investment expertise AND diversification.
Companies with a High Likelihood to Deliver
The key to long-term returns for any active investment manager is consistently finding stocks that outperform the market.
Yet while some chase hot sectors, themes, or market trends, a more reliable approach is consistently finding high-quality companies with promising outlooks and a sturdy financial footing.
Believing such fundamental thinking is superior to relying on hunches, hot trends, or guesswork, our efforts begin with a quantitative screen that highlights:
Followed by more qualitative analysis that looks at:
Through this process, we take our initial investable universe of more than 10,000 stocks from around the globe to a collection of around 200 names, all of which possess what we believe are solid growth prospects.
Sidestepping Those Loaded with Uncertainties
In the process of identifying what we believe to be the healthiest companies with the most promising outlooks, many names are cast aside.
But what are we really missing out on?
Consider that MarketWatch analysis found that 40% of the companies in the Russell 2000 Index lost money in 2022.
Few find that worrisome during periods of periods of low interest rates and a pervasive risk-on mindset, such as 2020-21. In fact, more speculative names tend to lead the market higher during such conditions.
When momentum shifts, however, due to factors such as dried up liquidity or a considerable slowdown in economic growth, what names usually suffer the most?
The riskier names that don’t have any earnings to fall back on.
As Warren Buffett shared at his 1994 annual meeting, “you don’t find out who’s been swimming naked until the tide goes out.”
And if you’re sitting in a passive index investment that automatically has exposure to those names, you have no choice but to absorb the hit to returns.
Optimizing the Benefits of Diversification
Sifting through the masses of publicly traded companies to determine those with the best chances for success is one thing.
Managing your investment in them is another.
Some active managers consider their mandate to hold 30-40 stocks, rationalizing that they’ve done the needed research to determine that each ranks among the top investment opportunities in their targeted universe.
That’s great, until one of those 30-40 names suddenly isn’t, due to a company development, an industry pivot, a sentiment change among Wall Street analysts, or some other unexpected shock. As the stock price retreats, fund performance suffers.
This is where we see the advantages of the broadly diversified portfolio. And to be clear, an active approach doesn’t mean simply amassing so many names that one day’s gainers will ideally more than make up for the same day’s decliners, but it’s ensuring that the portfolio’s exposure remains effectively balanced, regardless of the day’s direction.
For example, looking at our Growth Fund, our commitment to broad diversification features an alert whenever a stock weighting breaches the 2% threshold. That triggers a full assessment of the position and the reasons behind its rise—and frequently results in stock sales to bring the exposure back below 2% of the portfolio.
Yes, that means we trim names considered winners by most in the market, but we subscribe to a broader lens: The increased valuation also elevates the risk associated with that one name, which translates into a disproportionate importance in the portfolio.
For example, not long ago, we held an AI-related stock that soared more than four-fold in an 11-week period. Over the following month, it shed 40%.
Sure, we loved the stock’s sharp, rapid climb. But as it rocketed higher and claimed an increasingly larger allocation in the portfolio, Yorktown’s long-standing risk aversion kicked in, and we started putting in sell orders, which were generally scooped up by investors who wanted in.
Those moves helped alleviate the pain that followed shortly thereafter.
It All Comes Down to Risk
Ultimately, it doesn’t matter what kind of track record an investment has: a fund’s past performance doesn’t help anyone who invests today.
Conversely, risk mitigation is valuable whether you invested a decade ago or 10 minutes ago.
Most relevantly for Yorktown funds, market risk is the potential for losses stemming from macro events and broader volatility, while equity risk relates to the potential for an individual stock to lose value.
Inherently, passive index investments take on all of the market risk related to their underlying index, as well as 100% of the equity risk in each of its holdings.
Alternatively, actively managed funds the invest in select stocks in a highly-diversified way may offset a portion of those risks.
Which we believe is a better way.
Important Disclosures
You should carefully consider the investment objectives, potential risks, management fees, and charges and expenses of the Fund before investing. The Fund’s prospectus contains this and other information about the Fund and should be read carefully before investing. You may obtain a current copy of the fund’s prospectus by calling 800-544-6060.
Yorktown Funds are distributed by Ultimus Fund Distributors, LLC (member FINRA/SIPC). Yorktown Funds and Ultimus Fund Distributors, LLC are not affiliated. Check the background of Ultimus Fund Distributors, LLC on FINRA’s BrokerCheck: brokercheck.finra.org.