On the Industry Concentration of Actively Managed Equity Mutual Funds

Abstract

Mutual fund managers may decide to deviate from a well-diversified portfolio and concentrate their holdings in industries where they have informational advantages. In this paper, we study the relation between the industry concentration and the performance of actively managed U.S. mutual funds from 1984 to 1999. Our results indicate that, on average, more concentrated funds perform better after controlling for risk and style differences using various performance measures. This finding suggests that investment ability is more evident among managers who hold portfolios concentrated in a few industries. Copyright 2005 by The American Finance Association.

Is Concentration a Good Idea? Evidence from Active Fund Management

“…, 19 represents 19 industries, and t represents the first, second, third, and fourth quarter of each year. According to the definition of Kacperczyk et al (2005), the ICI equal to zero represents the mutual fund with exactly the same industry composition as the stock market, implying that mutual fund holds all industries in the whole market, and its performance is almost equal to the performance of the market portfolio. However, higher ICI represents that the industries held by the mutual fund diverge from the composition of the market portfolio.…”

“…In order to measure whether fund managers construct a concentrated portfolio to increase their performance, we use the industry concentration index (ICI) developed by Kacperczyk et al (2005) to measure the degree of concentration of open-end equity mutual funds in Taiwan. First, according to the industry classification provided by the Directorate General of Budget, Accounting and Statistics (DGBAS), we assign every stock held by a mutual fund to one of nineteen industries.…”

“…In general, mutual fund managers widely diversify their holdings across industries to reduce portfolio idiosyncratic risk and bring about significant benefits (Cardona 1998). However, a wide dispersion of holdings across industries not only carries potential cost, such as raising the cost of monitoring the performance of the stocks held or transaction cost due to increasing the number of stocks (Shawky and Smith 2005), but also restricts managers from completely using their informational advantages (Kacperczyk et al 2005). Consequently, fund managers with more information need to engage in concentrated strategy to beat the benchmark Moskowitz 1999, 2001;Nanda et al 2004).…”

“…Kacperczyk et al (2005) show that professional mutual fund managers have superior investment talent and widespread sources of information to construct an investment strategy for improving their investment performance. Consequently, it is reasonable to expect that fund managers with superior abilities hold a more concentrated portfolio for exploiting their talents.…”

“…Given that the profits of investors in the mutual fund market are influenced by the change in economic condition and volatility of the stock market, investigating the relation between the risk diversification and holding strategy of mutual funds through observing openend equity mutual funds in Taiwan can bring new insight for investors in emerging markets. Therefore, for demonstrating the relation between the risk diversification and holding strategy of mutual funds, we apply the industry concentration index developed by Kacperczyk et al (2005) and panel threshold regression model developed by Hansen (1999) to examine whether the degree of industry concentration of fund holdings impacts on the relation between their performance and risk premium.…”