The "Best Ideas" Portfolio: A Shortcut to Great Businesses

No noise. No predictions. Just structured thinking on equity investing.

The long-term underperformance of most actively managed funds relative to their benchmarks has long been documented.

But this fact isn’t a clear indictment of fund managers’ skill. It reflects mostly systemic constraints, fee structures, and poorly aligned incentives.

The good news for us is that the data shows we can still extract high-quality company ideas from all that noise.

The “Best Ideas Portfolio”

In a 2021 paper, Antón, Cohen, and Polk study U.S. equity mutual fund portfolios from 1983 to 2018. They extracted each fund’s “best ideas.”

A best idea is defined as the position that is most overweight:

• relative to the fund’s own portfolio

• relative to the fund’s benchmark (S&P 500, Russell 2000, etc.)

In other words, these are the companies in which managers have their highest conviction.

When we look at the performance of these companies, we see the following:

• An annual abnormal return of about 2.8% to 4.5% relative to standard factor benchmarks and to the rest of the managers’ portfolios.

• For a given manager, the best idea tends to outperform the other holdings in the fund.

This outperformance tends to persist over the long run.

“If one were to buy the best-ideas portfolios and hold those bets for the next decade, the resulting long-horizon abnormal performance would have been slightly over 20%.”

However, this outperformance is highly skewed across fund sizes:

• The best ideas of small funds outperform those of larger funds by a wide margin.

• The best ideas of very large funds show much weaker, sometimes even zero, outperformance.

This gives us a remarkable hunting ground: “high-quality” companies that have already passed through professional investors’ filters, especially in smaller and capacity-constrained funds.

Below is a list of some well-known funds, their managers, and approximate portfolio sizes, grouped by style. Substack’s support for tables is limited, so the cleanest way I found to present this was with a few screenshots:

The list of funds comes from Dataroma, which tracks the disclosed positions of well-known managers. Unfortunately, the site only shows U.S. holdings reported in 13F filings, so we don’t get the full set of positions for every portfolio.

I also recommend Morningstar if you want more granularity on performance and portfolio characteristics.

But the best approach remains the simplest: read the investor letters and the fund disclosures directly.

Most of my best positions have come from ideas sourced this way. I’ll highlight Kanen Wealth Management LLC in particular, whose ideas have contributed meaningfully to my market outperformance.

I’ll leave you with that.

Happy hunting.