The Sequoia Fund’s legendary status did it little good when its huge investment in a single risky biotech stock imploded over the past year, helping drive down the fund’s share price as much as 29%. Unlike Sequoia, whose investment in Valeant Pharmaceuticals International grew to 30% of the fund’s overall assets and whose dominant stock plummeted by as much as 90%, most funds spread their assets among many stocks. But from time to time, a fund manager becomes so convinced that a stock provides a golden opportunity that his/her fund makes an unusually large bet on a single stock—a bet that could make many investors uncomfortable.

How to avoid funds that bet too big on a single stock…

Reassess your fund if any one stock amounts to 10% or more of its assets. The Securities and Exchange Commission no longer considers a fund to be diversified once it has more than 5% of its portfolio in a single stock. I get worried when a position hits 10% because that’s when it could badly hurt performance and/or heighten volatility. About 50 stock funds recently held at least 10% of assets in a single stock. Examples: Nysa Fund (NYSAX), with 41% of assets in biotech firm Ligand Pharmaceuticals…and CGM Focus (CGMFX), 21% in home builder Lennar Corp.

Research how risky the top stock holding has been. For example, I’m not very worried about AMG Yacktman Focus (YAFFX) having 12% of its assets in Procter & Gamble, which over the past three years has been one-third less volatile than the S&P 500 stock index. On the other hand, Putnam Equity Spectrum (PYSRX) recently had 25% of its portfolio in shares of Dish Network, which has been 26% more volatile than the S&P 500.

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