R2 and the Benefits of Multiple-Fund Portfolios
Posted: 17 Jun 2013 Last revised: 8 Aug 2014
Date Written: July 17, 2013
Recent research shows superior performance of equity mutual funds which differ the most from their benchmarks. However, existing studies have not examined important questions about risk, such as the impact of holding a portfolio of low R2 funds on the reduction in portfolio risk achieved through diversifying across funds. Our study provides some answers. Using a variety of risk metrics, we evaluate the benefits of diversification among both monthly and annually reconstituted portfolios, where funds are sorted into portfolios based on their quintile rank of R2. We find that the benefits of diversification are most pronounced within a portfolio of low R2 funds, and that the benefits are increasing in the length of the reconstitution period.
Keywords: portfolio risk management, R-Squared, diversification, volatility, shortfall risk, Value at Risk, simulations, investment advisors, mutual fund performance, closet indexing
JEL Classification: G11, G17, G20, G23, C15
Suggested Citation: Suggested Citation