ANN ARBOR—Mutual funds perform better if their holdings are invested in fewer industries, according to the University of Michigan Business School’s new study on the industry concentration of U.S. equity funds.

“Though actively managed funds vary substantially in their portfolio concentration, funds with more concentrated portfolios perform better than funds with more diversified portfolios,” said Clemens Sialm, assistant professor of finance at the Michigan Business School. “This performance seems to be generated by a better stock-picking ability of managers.”

Sialm and colleagues Marcin Kacperczyk and Lu Zheng studied more than 2,000 actively managed diversified equity funds from 1984-1999 and found that mutual funds with above-median concentration yield an average abnormal return of 2.18 percent per year before expenses and 0.82 percent per year after expenses. On the other hand, more diversified mutual funds yield an average abnormal return of 0.39 percent per year before expenses and -0.73 percent per year after expenses.

“Conventional wisdom suggests that mutual fund managers should widely diversify their holdings across industries to reduce their portfolio’s idiosyncratic risk,” said Zheng, assistant professor of finance at the Michigan Business School. “However, fund managers might want to hold concentrated portfolios if they believe that some industries will outperform the overall market or if they have superior information to select profitable stocks in specific industries.”

The researchers found that mutual funds with more concentrated portfolios may, indeed, have informational or operational advantages and that the greater performance of these funds is due primarily to superior stock selection ability by their managers.

According to the study, managers of more concentrated funds overweigh growth and small stocks.

“Our results indicate that concentrated funds outperform diversified funds even after adjusting for industry performance,” said Kacperczyk, a doctoral student in the finance department at the Michigan Business School. “Interestingly, concentrated funds have the ability to select better-performing stocks within industries and are able to select better-performing industries overall.”

Related links:

• Michigan Business School
• Clemens Sialm
• E-mail: bernied@umich.edu