Effect of portfolio concentration on mutual fund performance: Evidence from Thailand
Post by MSF Chula at Sunday, 10 January 2021 05:03 PM

I examine the relation between portfolio concentration and performance of mutual fund in Thailand. To have a concentrated portfolio, a fund manager decides to invest more in particular stocks rather than holding a diversified portfolio. Trend of concentration in Thai funds has declined overtime. Recently, fund managers choose to hold diversified portfolio rather than concentrated funds. According to previous studies, the optimal concentration level is controversial. Most studies suggest the performance of active funds underperform passive funds after deducted expenses. On other hand, if the fund managers have valuable information about securities prices, increasing concentration can increase abnormal return. However, the strategy to increase concentration has its cost, which is higher volatility. If the portfolio has higher volatility, it can lower the return.

Consistent with this idea, I find that there is a negative relation between concentration and fund performance. One explanation could be because increasing concentration raise the volatility more than it increases the abnormal return. Thus, active funds cannot beat the market. Holding diversified portfolio is optimal. However, the strategy to hold concentrated works in certain circumstances. This study shows the strength of concentration should vary across different fund characteristics and market conditions. Increasing concentration when the funds have high liquidity or low expense ratio can increase risk-adjusted return. In view of the fact that low liquid funds cannot enhance their performance because of the limitation to spread liquidity-motivated trades while high liquidity funds can act on the information more effectively. In addition, investor who investor in low fee funds are high sensitivity to performance. Hence, fund managers would increase concentration or act on their information only when it will surely increase the risk-adjusted return.

Last updated at Sunday, 10 January 2021 05:03 PM