Diversification dilutes portfolio performance

Fund managers should focus on investing in stocks they are confident in instead of hedging their bets through diversification strategies, an academic believes.

Professor Ron Bird, director of the Paul Woolly Centre, said that new research was related to behaviour within fund management firms and how this translated into performance for clients, showing that attempts to diversify portfolios were not always beneficial for investors.

"The good news is that 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," he said.

"We often glorify diversification but fund managers should hold stocks that they are confident about and not be obsessed about building a diversified strategy."

Professor Bird said the evidence suggested that investors might be better served by diversifying their portfolios by using a number of small fund managers, who tend to be aggressive and hold large positions, instead of trusting one large fund management firm.

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"We looked at how fund managers behave through their corporate lifecycle," he said.

"They often start as a small fund, and are aggressive, and hold large positions. But as they get bigger and manage more money, they tend to become less aggressive and tend to protect their positions. They become more like index funds to the possible detriment of their clients.

"The clear message for investors is that they should stay away from large fund managers and look for managers that believe in concentrated investments."

While the four studies carried out by the Paul Woolly Centre — which he will present to the Australian Centre of Financial Studies next week — did not provide clear evidence of what made a good or bad fund manager, he said evidence suggested that managers who behaved as though they were "above-average" achieved the best performance.