Multi-Fund Diversification Issues

Connelly, Thomas J.
August 1997
Journal of Financial Planning;Aug1997, Vol. 10 Issue 4, p34
Academic Journal
This article focuses on the multi-fund diversification issues in portfolio management. The two most frequent concerns when planners get together to chat seem to be portfolio construction and mutual fund selection. The proliferation of funds and asset classes is making these tasks increasingly more complex and time consuming. More and more attention is being paid to interactions between funds and diversification issues, which is appropriate, since asset allocation via modern portfolio theory is currently the modus operandi in the business. Research suggests that between 10 and 40 properly chosen stocks are sufficient to diversify away the bulk of nonsystematic risk. Many investors use that many equity funds in their portfolios. The performance history of publicly offered funds of funds appears to be uninspiring. Cost could be looked at as the marginal reduction of return as new funds are added, or by comparison to passive or indexing strategies. The relative costs of diversification using mutual funds are largely additional operational costs, part of the costs of active management. Using nondiversified funds, which require managers to focus on their best 10 to 30 stock picks within their style mandate, could focus the competitive advantages of each stock picker, while reducing duplications and portfolio deadweight.


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