At the opposite end of the spectrum from the diversification stressed by Modern Portfolio Theory (MPT) are concentrated portfolios, which have made investors including Warren Buffett, George Soros and Martin Whitman famous. Often composed of 10 stocks or fewer, concentrated portfolios usually have a relatively small number of holdings, which may provide diversification among asset classes and sectors, but may also be allocated in a manner that provides little if any diversification.

Pershing Square’s Holdings

Bill Ackman, founder and CEO of the hedge fund Pershing Square Capital Management, is also a proponent of concentrated portfolios. This is evidenced by the makeup of his fund, which was founded in 2003. As of May 16, 2016, his fund had a total of nine long positions, with Zoetis Inc. (NYSE: ZTS) and Canadian Pacific Railway Limited (NYSE: CP) combining to compose over 40% of the portfolio. The two most notorious holdings in the hedge fund are Valeant Pharmaceuticals International Inc. (NYSE: VRX), in which the fund has lost billions, and a highly publicized short position in Herbalife Ltd. (NYSE: HLF), which has generated losses for the fund since 2012.

The fund, which posted a compound annual return of 17.1% from 2004 through 2015, soundly beating the 7.4% annualized gain of the Standard & Poor’s 500 Index (S&P 500), provides lessons in both the advantages and disadvantages of concentrated portfolios. There is also a lesson in timing, as Pershing Square Holdings Ltd. (OTC: PSHZF), the publicly traded security for the hedge fund, was down almost 50% from its high in August 2015, as of June 9, 2016.

Advantages of Concentrated Portfolios

The key advantage of concentrated portfolios is the potential for a small number of companies to drive market-beating returns for the entire portfolio. For example, Canadian Pacific, which operates a transcontinental railway transporting a variety of bulk commodities, has been one of Pershing Square’s biggest winners and was also the fund’s second-largest holding at 20.89%, as of May 16, 2016.

In addition to non-diluted returns, a low number of holdings enables portfolio managers and their teams the opportunity to study all aspects of existing companies, as well as prospective investments. The concentrated portfolio of Pershing Square also enables Ackman to be an activist investor and board member of companies held by his fund. He currently sits on several boards, including Valeant and Canadian Pacific. He was also a member of the board of J.C. Penney Company Inc. (NYSE: JCP) until Pershing Square sold out its holdings in 2013, resulting in a loss of approximately $500 million.

The issues of knowledge and participation were pointed out at length in the Pershing Square Holdings letter sent to its shareholders in January 2016, in which Ackman criticized index-based fund managers for relying on hedge funds to make sure corporations follow good governance protocols. The letter also highlighted the inability of index-based portfolio managers to sift through thousands of corporate reports and proxy statements quarterly, essentially saying the funds are investing blindly in corporations without truly knowing what corporate managers are doing.

Concentrated Disadvantages

A limited number of holdings can also wreak havoc on fund returns when share prices reverse, as Pershing Square experienced in 2015 and the first quarter of 2016. In 2015, Pershing Square had a negative return of 20.5%, due primarily to steep losses in Valeant and Canadian Pacific. From its August 2015 high through the end of the year, Valeant lost 61%, while Canadian Pacific lost 33% over the course of the year. In the first quarter of 2016, Pershing Square lost an additional 25% as Valeant plummeted 75% from its Dec. 31, 2015 close. Herbalife, in which the fund has a short position, appreciated by 13%.

History Repeats

From 2004 through 2014, Pershing Square’s concentrated portfolio strategy delivered gross annualized returns of 25.3%, earning Ackman accolades as one of the top 20 hedge fund managers, based on total returns to investors. As the fund’s assets grew, staying with a concentrated portfolio approach required the fund to refocus on larger companies in which it took smaller percentages of ownership, which limited Pershing Square’s power as an activist shareholder.

With the fund at its largest in terms of assets under management (AUM) in 2015, Pershing Square suffered its worst losses since inception. This performance arc is similar to the fund Ackman managed prior to Pershing Square. In 200, Gotham Partners was shuttered after Ackman changed his investment strategy as the fund’s AUM multiplied. While Pershing Square is unlikely to go the route of Gotham Partners, its investors are suffering, and the fund now has a long climb back to its high watermark. As George Santayana said, “Those who cannot remember the past are condemned to repeat it.” At this point, it appears Bill Ackman forgot about Gotham Partners.