A desire for diversification is diluting the best ideas of active managers, shows a study carried out by Professor Ron Bird, a director of the Paul Woolley Centre.

A study of stocks held by US mutual funds from 1995-2012 has led Bird to the conclusion that many would be better off sticking to their best 15 ideas – anything more tends to dilute performance.

“Fund managers do have good stock selection skills, but after selecting their key stocks they tend to diversify their portfolios with stocks that dilute performance. We often glorify diversification but fund managers should hold stocks that they are confident about and not be obsessed about building a diversified strategy,” he said.

He is presenting his findings in a briefing at the Australian Centre for Financial Studies/ FINSIA offices in Melbourne today.

One of his studies charts how fund managers often start as small firms holding aggressive positions, but as they manage more money and have more to lose they tend to diversify becoming more like index funds. He backs this assertion with the Warren Buffett quote: “Diversification is protection against ignorance.”

“The clear message for investors is that they should stay away from large fund managers and look for managers that believe in concentrated investments,” he said. “So rather than holding one big diversified portfolio, they should look at several small, concentrated portfolios.”

The studies carried out by Bird over three years focus on behaviour within fund management firms and how they translate into performance for clients. One finding is value as an investment style does outperform, but chance is still a big factor.

“It’s an industry governed by chance. So we need to look at behavioural traits. Evidence strongly supports that managers who behave as though they are above-average, achieve the best performance,” he said.



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