merkhet Posted June 22, 2014 Share Posted June 22, 2014 A research paper that finally talks about what we in the CoBaFF community have known all along. Some highlights include: The paper also has strong implications for the optimal behavior of investors in managed funds. Our findings suggest that while the typical manager has a small number of good investment ideas that provide positive alpha in expectation, the remaining ideas in the typical managed portfolio add no alpha at all. Managers have understandable incentives to include these zero-alpha positions. Without them, the portfolio would contain only a few names, leading to increased volatility, price impact, illiquidity, and regulatory/litgation risk. Adding additional stocks to the portfolio can not only reduce volatility but also increase portfolio Sharpe ratio. Perhaps most important, adding names enables the manager to take in more assets, and thus draw greater management fees. But while the manager gains from diversifying the portfolio, it is likely that typical investors are made worse off. We suggest that investors who put only a modest fraction of their assets into each managed fund can have substantial gains if managers choose less-diversified portfolios. It's the Kleig-light syndrome -- you get the behavior you incentivize, so when you incentivize volatility and Sharpe ratios, you get crappy portfolio returns. Noted again here: Second, the very nature of fund evaluation may cause managers to hold some or even many stocks on which they have neutral views concerning future performance. In particular, since managers may be penalized for exposing investors to idiosyncratic risk, diversification may cause managers to hold some stocks not because they increase the mean return on the portfolio but simply because these stocks reduce overall portfolio volatility. Enjoy my fellow concentrated investors. :) [Note: I didn't see that this was published all the way back in 2009 -- so others may already have seen this]Best_Ideas_Research_Paper.pdf Link to comment Share on other sites More sharing options...
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