This stock investing strategy has blown away the S&P 500. Here’s a way to refine it for quality.

The $1.5 billion William Blair Large Cap Growth Fund
LCGNX,
+0.20%
is rated four stars (out of five) within Morningstar’s “Large Growth” fund category. It held 33 stocks as of May 31. By definition, the fund is concentrated, but it is weighted differently from the largest holdings of its benchmark, the cap-weighted Russell 1000 Growth Index
RLG,
+0.01%.

Here’s how the fund’s Class I shares have performed over the past 10 years, compared with exchange-traded funds tracking the two indexes mentioned above — the iShares Russell 1000 Growth ETF
IWF,
+0.22%
and the SPDR S&P 500 ETF Trust
SPY,
+0.35%,
all with dividends reinvested:

The William Blair Large Cap Growth Fund has underperformed the Russell 1000 slightly over the past 10 years, but both approaches have outperformed the S&P 500 by a wide margin.

And this points to features of the fund that may be attractive to investors who wish to continue to ride the wave of growth with a more selective quality strategy.

Some investors are unaware of how highly concentrated a cap-weighted index can be. For the S&P 500, the top five companies — Apple Inc.
AAPL,
-0.36%,
Microsoft Corp.
MSFT,
-0.16%,
Amazon.com Inc.
AMZN,
+1.19%,
Nvidia Corp. and two common-share classes of Alphabet Inc.
GOOGL,
+0.89%

GOOG,
+0.98%
— make up 24% of the SPY portfolio. The top 10 companies make up 32% of the index.

The Russell 1000 Growth Index is a subset of the Russell 1000 Index
RLG,
+0.01%
of the largest companies publicly listed in the U.S. The 444 companies in the Growth index are those with relatively high price-to-book ratios, with higher five-year revenue growth rates and higher forecast growth rates over the next two years. You can read FTSE Russell’s full description of the index here. It is more concentrated than the S&P 500.

Concentration risk and concentration on quality

The iShares Russell 1000 Growth ETF’s top 10 holdings (again, with two common-share classes for Alphabet) make up 53% of the portfolio:

And here are the largest 10 holdings of the William Blair Large Cap Fund as of May 31, with estimated compound annual growth rates(CAGR) for the next two calendar years, based on consensus estimates among analysts polled by FactSet:

Click the tickers for more about each company, fund or index.

Click here for Tomi Kilgore’s detailed guide to the wealth of information available for free on the MarketWatch quote page.

For half the listed companies, the expected two-year sales CAGR are higher than those of the iShares Russell 1000 Growth ETF, which itself has considerably higher expected growth numbers than those of the S&P 500.

Two-year expected CAGR isn’t yet available for Accenture PLC
ACN,
+0.05%
or for Copart Inc.
CPRT,
+0.47%.
For Accenture, analysts expect revenue to increase by 6.1% in 2024, with EPS increasing by 8%. For Copart, sales are expected to increase 9.3% in 2024, with EPS rising 16.1%.

The William Blair Large Cap Fund is a high-conviction low-turnover portfolio, with only 33 stocks and the top 10 making up 57% of the portfolio, with Microsoft at the top making up nearly 15%. But as you move down the top-10 list, you can see clear differences in the top holdings, compared with companies taking up the most weight in the Russell 1000 Growth Index.

MarketWatch readers have commented that when they pay for active management, they want to see a portfolio that doesn’t mirror a benchmark index. In this case, the William Blair Large Cap Fund charges 0.90% of assets under management annually, compared with an expense ratio of 0.18% for the passively managed iShares Russell 1000 Growth ETF.

The William Blair Large Cap Fund has a 62.48% active share, according to Morningstar. That is a measure of how much an actively managed fund differs in investment exposure from its benchmark index. You can read about how Morningstar assesses active shares here.

Golan, who is based in Chicago, where William Blair & Co. is headquartered, said that he and David Ricci, who co-manages the fund, typically have investment horizons of three to five years when selecting stocks. But the fund has held Microsoft for nine years and hasn’t sold any of the company’s shares for several years. Microsoft’s stock appeared to be “mispriced” after languishing for an extended period before the fund made its purchase in 2014, he said.

Microsoft is no longer considered a cheap stock, however, Golan sees years of rapid growth ahead with the deployment of artificial intelligence and increasing revenue from its Azure web services unit.

He also expects Microsoft to expand its profit margins. “We think this company can grow revenues by double digits over the next five years, with EPS [earnings per share] growing more quickly than that,” he said.

For AI specifically, he pointed to Microsoft 365 Copilot, an add-on for Office and other products, which could be especially useful in the corporate environment. For example, if you are using Teams for a work meeting, Copilot will be able to take the meeting minutes for you. It is easy to envision wide adoption of this type of AI assistance for a small monthly add-on to an Office subscription.

Golan stressed that the fund is focused on companies that are in strong financial condition that he expects to continue growing at a good pace, and for which earnings and cash flow are stable.

Another example of this type of company is Costco Wholesale Corp.
COST,
+0.11%,
which benefits from customer loyalty and which has continued opportunities for expansion in the U.S., Europe and China, a market it has just entered, Golan said.

He emphasized the fund’s bottom-up approach to analysis and selection of “secular growth companies that should do well over the long hall,” regardless of economic or market conditions.

A fairly recent purchase Golan mentioned was Palo Alto Networks Inc.
PANW,
+1.25%,
which has been “putting up excellent numbers” as corporate customers keep spending more on cybersecurity, “an area on which you cannot skimp.”

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