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cooking, i.e., the managers should personally invest in the fund, and of course (d) invest on Graham-and-Dodd principles.25 Goldfarb’s ten funds come quite close to these strict guidelines.

(a) A limited number of stocks. The average domestic equity fund holds about 160 stocks,26 suggesting a good reason for the common academic criticism that fund managers as a whole should not expect to outperform the market index. Owning half of all the outstanding shares, mutual funds as a group will inevitably mirror the index. And given their fee structures and substantial transaction costs, they must in fact do worse.

The ten funds in the study held at year-end 2003 only 54 stocks on average, barely one- third as many as the typical fund, and even that number is inflated by the geographically diverse, large foreign stock holdings of two of them, First Eagle Global and Mutual Beacon. Seven of the ten had 34 stocks or less. Contrary to the advice of financial economists, investment advisers, and stock market writers, value funds seem convinced that safety lies in careful selection, not random diversification.

The huge bonus of a concentrated portfolio is that you can buy a large amount of what you really like. Munger likes to say that when you find a really good opportunity, “don’t buy just a little, back up the truck.”27 At calendar year-end 2003, the top five stocks in Legg Mason’s portfolio accounted for 34% of the total. Others with concentrated top-five holdings included Longleaf Partners – 28%; Oakmark Select–40%. Thus value funds need only a few good ideas out of the roughly 2,000 stocks of sufficient size, that is, those with market capitalizations over $1 billion. With so many choices, it’s easy, as our group of funds did, to steer clear of the red flags that were flying high at Enron.28 Highly diversified funds needed a reason not to invest in Enron. Those in our group needed a reason to invest. This very different approach naturally led to different results. 34 or 500: Indexing

So where does that leave indexing? It’s the obvious choice for the neoclassical economists who still believe in EMT, but its popularity doesn’t stop there. Shiller, for example, recommended indexing, so as to diversify away “all risks.”29 To be sure, an investor would have


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