This Day On The Street
Continue to site right-arrow
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
TheStreet Open House

Why Some Fund Managers Avoid the Biggest Stocks

NEW YORK ( TheStreet) -- Plenty of fund managers like to own top dogs, stocks that have the biggest market values in their sectors.

Familiar names in the elite group include Apple (AAPL - Get Report), Johnson & Johnson (JNJ - Get Report) and Coca-Cola (KO - Get Report). Investors figure that the biggest stocks are stable choices with strong growth potential.

But some portfolio managers are wary of buying the No. 1 stocks. Instead, they tend to prefer stocks that rank second or lower. "In general, the No. 2 stocks tend to be cheaper, and they can be more dynamic," says Tom Forester, portfolio manager of Forester Value (FVILX). "The No. 2 managements can be a little more aggressive because they are trying to get the lead. The No. 1 companies may be more cautious because they are trying to protect their leads."

No. 1 companies usually deliver poor returns, according to a study by Rob Arnott, chairman of Research Affiliates and portfolio manager of PIMCO All Asset (PASAX). During the first year after they became top dogs, 59% of the companies underperformed their sectors, Arnott found. Over the next decade, two-thirds lagged their sectors. On average, top dogs trailed by more than 3 percentage points over 10 years.

Arnott says that companies move to the top of the heap by having superior products and shrewd managements. Investors bid up the stocks, figuring that the strong performance will continue. But all too often, the shares become overpriced, which hurts future returns.

Once they gain the top positions, companies have trouble remaining dominant because smaller competitors develop innovative products and steal market share. In addition, regulators often take aim at the top dogs. As a result, No. 1 companies regularly lose their leading positions. In the 1980s, the government dismantled top dog AT&T (T), arguing that it was too powerful. A decade ago, Washington attacked Microsoft (MSFT), claiming it was a monopoly. That slowed the company's growth at a time when small competitors were nipping away at market share. Microsoft soon lost its No. 1 position in technology.

Arnott says that top dogs tend to begin slipping within a few years of gaining their No. 1 position. During the past 60 years, the average industry sector had six different top dogs. One exception has been energy. For the entire six decades, Exxon Mobil (XOM) and its predecessors have held the top position. Arnott speculates that the company has maintained an edge by focusing on its core business and avoiding expensive combat with regulators and competitors.

1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Try it NOW
Only $9.95
Try it NOW
14-Days Free
Try it NOW

Check Out Our Best Services for Investors

Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Options Profits

Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • Actionable options commentary and news
  • Real-time trading community
Try it NOW
Try it NOW
Try it NOW
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
SYM TRADE IT LAST %CHG
AAPL $124.24 0.70%
JNJ $100.12 -0.22%
KO $40.35 -0.25%
FB $83.01 0.11%
GOOG $555.17 -0.65%

Markets

DOW 17,678.23 -40.31 -0.23%
S&P 500 2,056.15 -4.90 -0.24%
NASDAQ 4,863.3620 -13.1570 -0.27%

Partners Compare Online Brokers

Free Reports

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs