The Diversification Factor in Mutual Fund Returns

27 Pages Posted: 18 Aug 2017

See all articles by Bernd Hanke

Bernd Hanke

Global Systematic Investors LLP

Aneel Keswani

Faculty of Finance, Cass Business School, City University, London

Garrett Quigley

Global Systematic Investors LLP

David Stolin

Toulouse Business School - Economics and Finance

Maxim Zagonov

Toulouse Business School, Université de Toulouse

Date Written: August 18, 2017

Abstract

Active portfolios can be more concentrated or more diversified than the market portfolio. In the latter case, the result is likely to be a tilt toward equal weights, which would impact portfolio returns in a systematic manner. To capture this tilt, we construct a simple diversification factor as the difference between returns on equal weighted and value weighted portfolios for the relevant universe. Our diversification factor accounts for up to one-half of the otherwise unexplained variation in active mutual funds’ returns. We therefore argue that the diversification factor should be used in performance evaluation of broad market equity portfolios.

Keywords: mutual funds, factor models, diversification return

JEL Classification: G11, G23

Suggested Citation

Hanke, Bernd and Keswani, Aneel and Quigley, Garrett and Stolin, David and Zagonov, Maxim, The Diversification Factor in Mutual Fund Returns (August 18, 2017). Available at SSRN: https://ssrn.com/abstract=3021719

Bernd Hanke

Global Systematic Investors LLP ( email )

45 King William Street
1st Floor
London, EC4R 9AN
United Kingdom

HOME PAGE: http://www.gsillp.com

Aneel Keswani

Faculty of Finance, Cass Business School, City University, London ( email )

106 Bunhill Row
London EC1Y 8TZ
Great Britain
+44 207 040 8763 (Phone)

Garrett Quigley

Global Systematic Investors LLP ( email )

75 King William Street
London, EC4N 7BE
United Kingdom

HOME PAGE: http://www.gsillp.com

David Stolin

Toulouse Business School - Economics and Finance ( email )

20, bd Lascrosses - BP 7010
Toulouse Cedex 7, 31068
France

Maxim Zagonov (Contact Author)

Toulouse Business School, Université de Toulouse ( email )

20 bd Lascrosses
Toulouse, Select State 31068
France
+33(0)561294974 (Phone)
+33(0)561294994 (Fax)

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