1/ Interesting paper by Harvard and IESE Business School that shows that fund managers have the ability to outperform with their best ideas but fall prey of "diworsification"
🔗hbs.edu
🔗hbs.edu
2/ We've heard many times that almost every manager fails to outperform the market and we automatically link it with an inability to pick stocks.
The paper shows that many managers do know how to pick stocks, but they dilute their best ideas' performance adding other holdings
The paper shows that many managers do know how to pick stocks, but they dilute their best ideas' performance adding other holdings
3/ The study goes from 1983 to 2018, period in which the average mutual fund managed around $2 billion and held 160 stocks! (yes, you read that right, 160!)
So, why don't managers concentrate in their best ideas? There are 4 reasons
So, why don't managers concentrate in their best ideas? There are 4 reasons
4/ Reason #1: Regulatory/legal: concentrated portfolios can lead to increased litigation
5/ Reason #2: Liquidity and asset gathering: more AUM means more fees, so managers have incentives to build large portfolios. For liquidity reasons they must spread out their bets
6/ Reason #3: Manager risk aversion: investors in the fund typically have other holdings but fund managers rarely do, so they tend to overdiversify to protect their job and wealth
7/ Reason #4: Investor irrationality: Morningstar's rating favors Sharpe ratios so it's difficult to get a top rating with a concentrated fund
8/ All in all, fund managers know how to pick stocks, but they dilute their best picks with overdiversification which occurs due to the reasons discussed above
9/ Research also shows that almost 90% of the benefits of diversification can be achieved with 20 holdings.
It's unlikely that any investor can keep up with more than 20 companies anyways, so that seems to be a decent upper limit
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It's unlikely that any investor can keep up with more than 20 companies anyways, so that seems to be a decent upper limit
/END/
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