Limited Attention and Portfolio Choice: The Impact of Attention Allocation on Mutual Fund Performance

Abstract:     
This study proposes that mutual fund performance increases with the efficiency with which attention-constrained fund managers allocate attention among assets during portfolio choice. We develop a new fund-level measure, called attention gap, which aggregates the stock-level mismatch between the attention demanded (or effort required for analysis) by a stock in a fund manager’s investment set and the attention allocated to the stock by the fund manager. The results indicate that fund performance increases when attention gap decreases, i.e. when fund managers allocate more attention toward the stocks with the highest attention requirements. Funds ranked in the highest decile based on attention gap underperform the funds in the lowest decile by up to about 300 basis points per year on a risk-adjusted basis. Also, supporting Kahneman’s (1973) hypothesis that attention allocation becomes less relevant to outcomes when the overall attention demand of the tasks facing the investor is high, we find evidence that the impact of attention gap on fund performance decreases with the total attention demand of the fund managers’ tasks. Our findings serve as novel evidence proposing efficient attention allocation as a dimension of investor skill that affects investment performance when attention is finite.

Number of Pages in PDF File: 37

Keywords: limited attention, mutual fund performance, attention allocation, portfolio choice

JEL Classification: G11, G23

working papers series