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Pearson and the risks of over-concentration

Tom Stevenson

Tom Stevenson - Investment Director

Educational publisher Pearson warned today that its profits will fall this year and said that its finance director is leaving the company.

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With Pearson’s chief executive having also recently announced his departure later this year, it is clear that the company is struggling with a well-publicised and painful transition from media conglomerate to focused digital education services provider.

The company’s shares tumbled by 14% on the news and have now fallen by 40% in the past year.

Pearson is a fascinating corporate case study, having changed its spots many times over the years. Back in the middle of the 19th century the company started out as a building and engineering company and along the way it has had interests in merchant banking (through Lazard Brothers), publishing (it owned the Financial Times, half the Economist and Penguin), and entertainment via Madame Tussauds.

More recently, it has become a pure-play digital publisher, trying to carve out a dominant niche in North American educational publishing where the move from textbooks to online learning is well advanced. It is hard going. Sales in its US university business, which make up a quarter of revenues, were down 12% last year.

Pearson has frequently come up in conversations we have held with Select 50 managers. At one point last year, the company was the only holding which appeared in the portfolios of both quality, growth specialist Nick Train and contrarian value investor Alex Wright. Both have placed relatively large bets on the company, bets which neither manager will be very pleased with today.

The Lindsell Train UK Equity Fund, a former Select 50 fund and one of our best fund recommendations in 2019, has reduced its exposure to Pearson over time. It is no longer in the fund’s top ten holdings. Nick Train is, however, acutely aware that he has staked part of his reputation on this particular stock pick.

He said in his most recent monthly note to investors that ‘2020 is an important year for the company, when investors should really be able to judge whether the multi-year investments it has made into digitising its intellectual property will ever pay off (and hence an important year for us as possibly overly patient investors in it).’

Rather against expectations, it is the Fidelity Special Situations Fund which has the greater exposure to Pearson, however. With over 4% of Special Sits’ assets invested in the company it is one of the fund’s biggest holdings, roughly twice the exposure of the Train fund.

A 40% fall over one year in a stock representing 4% of assets is not a disaster. But it still accounts for a drag of roughly 1.5% on the fund over 12 months. Manageable but a major irritant and a reminder of the risks of putting too many eggs in one basket when it comes to managing a portfolio.

Close watchers of the Select 50 will know that we recently removed the Lindsell Train UK Equity Fund from the Select 50. One of the reasons our fund selectors cited was the high level of concentration in a fund with only 23 holdings - 60% of the fund’s assets are accounted for by the top ten holdings.

Although Fidelity Special Situations is the bigger victim of the latest news from Pearson, it is overall significantly less concentrated than the Lindsell Train fund. It has 71 holdings and the top 10 account for a more manageable 43% of assets.

The appropriate level of concentration for a fund is a topic of hot debate. While we argue frequently for the merits of diversification, it is also the case that a fund can have too many holdings - what is sometimes called di-worsification.

The argument against too broad a spread of investments is that an individual good stock performance loses the ability to really impact the overall fund returns. What a well-diversified portfolio can take in its stride, however, is the occasional Pearson. The smoother ride of a well spread portfolio is one of the principal reasons for investing in funds rather than single shares.

Managing risk is a key part of investing your savings. Risk and reward was one of the topics we explored in our recent Invest for Life series. Watch the episode below.

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Five year performance

(%) As at 15 Jan 2015-2016 2016-2017 2017-2018 2018-2019 2019-2020
Pearson -38.6 22.6 -5.2 36.9 -35.2

Past performance is not a reliable indicator of future returns

Source: FE, as at 15.1.20, in local currency terms with income reinvested

Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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