Hennessy & Associates manages a $30 million equity portfolio for the multi-manager Wilstead Pension Fund. Jane Jones, financial vice-president of Wilstead, noted that Hennessy had rather consistently achieved the best record aamong the Wilstead's six equity managers. Performance of the Hennessy portfolio had been clearly superior to that of the S&PffSX Composite Index in four of the past five years.
In the one less-favourable year, the shortfall was trivial. Hennessy is a bottom-up manager. The firm largely avoids any attempt to "time the market." It also focuses on selection of individual stocks rather than the weighting of favoured industries.
There is no apparent conformity of style among Wilstead's six equity managers. The five managers, other than Hennessy, manage portfolios aggregating $250 million
made up of more than 150 individual issues. Jones is convinced that Hennessy is able to apply superior skill to stock selection, but the favourable returns are limited by the high degree of diversification in the portfolio. Over the years, the portfolio generally held 40-50 stocks, with about 2%-3% of total funds committed to each issue. The reason Hennessy seemed to do well most years was that the firm was able to identify 10 or 12 issues each year that registered particularly large gains. On the basis of this overview, Jones outlined the following plan to the Wilstead pension committee: Let's tell Hennessy to limit the portfolio to no more than 20 stocks. Hennessy will double the commitments to the stocks that it really favours, and eliminate the remainder.
Except for this one new restriction, Hennessy should be free to manage the portfolio exactly as before. All the members of the pension committee generally supported Jones's proposal because all agreed that Hennessy had seemed to demonstrate superior skill in selecting

a. Will the limitation to 20 stocks likely increase or decrease the risk of the portfolio? Explain.
b. Is there any way Hennessy could reduce the number of issues from 50 to 20 without significantly affecting risk? Explain. stocks. Yet the proposal was a considerable departure from previous practice, and several committee members raised questions. Respond to each of the following questions.