Portfolio selection, diversification and fund-of-funds: a note

Abstract

The present paper examines the performance and diversification properties of active Australian equity fund-of-funds (FoF). Simulation analysis is employed to examine portfolio performance as a function of the number of funds in the portfolio. The present paper finds that as the number of funds in an FoF portfolio increases, performance improves in a mean-variance setting; however, measures of skewness and kurtosis behave less favourably given an investor's preferences for the higher moments of the return distribution. The majority of diversification benefits are realized when a portfolio of approximately 6 active equity funds are included in the FoF portfolio. Copyright 2005 Accounting and Finance Association of Australia and New Zealand..

Pricing assets with higher moments: Evidence from the Australian and us stock markets

“…For instance, Beedles (1986) and Alles and Spowart (1995) find that Australian stocks exhibit significant skewness. Furthermore, Bird and Gallagher (2002) and Brands and Gallagher (2004) document that Australian mutual funds are characterized by a leptokurtic distribution. In particular, they noticed that portfolio returns of larger funds had more negative skewness and larger kurtosis relative to smaller mutual funds.…”

Funds of Funds' Portfolio Composition and its Impact on Performance: Evidence from the Italian Market

“…19 Empirical analysis show that higher benefits are obtained by portfolios that invest in ten or twenty funds in function of the correlation between single portfolios 20 but there is evidence that demonstrate that, in particular markets, the number of funds is significantly lower. 21 The reduction of benefits related to the diversification could be explained analyzing the inefficiencies of multi-funds portfolios: a higher segmentation of wealth on different funds' managers increases the probability of duplication of holdings and it's also probable that strategies adopted by different funds' managers are not tuned. 22 The number of funds to include in a hypothetical portfolio depends on the risk profile of a typical subscriber, on the sectorial and geographical specialization and on the covariance between different sectors and geographical areas.…”

“…27 Empirical studies demonstrates that managers who adopt the same investment style achieve results that are highly correlated and so a funds' selection based on the investment style could be useful to construct a well diversified portfolio. 28 The assumption of time persistence of results achieved by funds' manager makes rationale to consider the past performance in selecting funds. 29 FoFs' managers that adopt this approach analyze performances achieved in last years and the risk related to the portfolio managed and they try to identify best active managers.…”

A model of emulation funds

“…Indeed, Lhabitant and Learned () and Brands and Gallagher () show that significant reductions in manager‐specific risk can be achieved with five to ten different fund managers. Beyond this, adding more underlying funds may be detrimental to the skewness and kurtosis of portfolio returns (Brands and Gallagher, ) and may decrease potential alpha (Gallagher and Gardner, ). However, there has been little work on the level of trading redundancy that multimanager frameworks exhibit.…”