Reclassify fund as non-diversified

Factual Questions
1

I recently received a letter from my 401k firm with the following statement:

What does this mean if I were in one of the funds?

2

A summary: A non-diversified fund means the fund can put the majority of its holding into one industry. Like The Acme Tech Fund could be 64% Tech companies or Allied Mining is 83% Mining Companies and Petroleum. The fund is still restricted to <=5% in a single company though.

3

A diversified investment company is defined by 15 U.S.C. 80a-5(b), and it generally means that it has to invest in mix of investments rather than being concentrated in a single stock or other security. Specifically, at least 75% of its assets have to be invested in a combination of:

  • cash and cash equivalents,
  • government securities,
  • securities of other investment companies (e.g., mutual funds), and
  • securities of any other issuer as long as that security isn’t greater than 5% of the fund’s value and not more than 10% of the outstanding voting securities of the securities’ issuer.

So, even in a diversified fund, up to 25% of the portfolio can be invested in a single stock, as long as the remainder is invested in a more diversified way. Non-diversified funds can basically invest in a portfolio that is as concentrated as they choose. In an extreme example, a non-diversified fund could invest in just Apple and Amazon if it so chose.

They are telling you it’s non-diversified because that is one sign that the fund might be extra risky. Furthermore, a diversified fund has to get shareholder approval to switch to a non-diversified strategy, which means you will at least know ahead of time if the fund suddenly adopts a riskier concentrated strategy. If you buy a non-diversified fund, the buyer should beware that the fund can make some pretty dramatic portfolio changes without advance notice.

This is not true even for diversified investment companies and it is super-duper extra wrong for non-diversified companies. The Vanguard S&P 500 fund is diversified in both common parlance and by the legal definition. It currently holds over 6% of its assets in Apple.

By contrast, Oakmark Select aims to own no more than 20 stocks, and it’s largest holding is nearly 10% of the fund.

4

Thanks for the correction, I must have misunderstood something I learned in the past.

5

So if one were an energy fund and another a utility, being non-diversified they can dump the parts that don’t match their core and concentrate on a smaller part of the market. Got it.