The idea that institutional investors are the biggest players in the market is nothing new, but a quote from the Wall Street Journal, recounted by Robert Folsom of Elliott Wave International really caught my eye.

“Institutional investing is now largely the business of giants. America’s 100 largest money managers alone now hold 58% of all stocks.”

This reminded me of a comparison of mutual fund holdings I used in my college class a few years ago where the 3 largest stock mutual funds of the time had 9 of their 10 largest holdings that were exactly the same. The moral of that story: Diversifying among the 3 most popular funds did next to nothing to increase the safety of your investments.

Another flaw in bigger-is-better investing is that they cannot adapt to changes in the markets. The biggest funds often have over $3 billion in their top stock pick. $3 billion! In one company! If they were to try to sell just a fraction of that at one time the market would probably collapse. What management can do at the biggest funds is very limited by their size. The manager might as well be hog-tied.

And these same biggies now make up the majority of retirement plan management and investment choices.

The truth is this: An ever-larger number of people give their money to an ever-smaller number of managers, who in turn invest in increasing similar ways. This kind of diversification – or better yet, lack of diversification – is just flat unhealthy and someday will result in devastating losses to participants.

If you really expect a manager to manage, he can’t have his feet stuck in concrete like the biggies do. Smaller is better if you ask me.

To put things in perspective, my moderate growth strategy, called The All-Star Line-up currently holds 28 different mutual funds and 20 of these funds have less than $1 billion in assets spread over hundreds of individual holdings. If needed, they can quickly sell holdings without driving the market down because they are small. This makes these undiscovered stars nimble and allows them Adapt to Changing Markets^® in ways the big funds just can’t do.

from the Financial Market Review, March 2007