The Decision to Concentrate: Active Management, Manager Skill, and Portfolio Size

51 Pages Posted: 7 Sep 2017

See all articles by Keith C. Brown

Keith C. Brown

University of Texas at Austin - Department of Finance

Cristian Ioan Tiu

University at Buffalo; TIAA Institute

Uzi Yoeli

University of Texas at Austin - Department of Finance

Date Written: August 9, 2017

Abstract

Several recent studies establish that more highly concentrated portfolios produce superior risk-adjusted returns. The untested premise of this literature is that it is the most skillful managers who hold the most concentrated portfolios. In this study, we formally examine the implicit assertion that the initial portfolio concentration decision is meaningfully related to a manager’s inherent investment skill. First, we present a simple theoretical model showing that the greater the manager’s skill level, the more concentrated the portfolio should be. Second, we conduct an extensive simulation analysis of the capacity to make accurate ex ante security return forecasts and show that skilled managers would select only about 3-20% of the available securities and that the portfolio concentration decision is directly proportional to investment prowess. Finally, we provide an empirical examination of the actual skill-concentration relationship for actively managed U.S. equity funds over 2002-2015, documenting that managers who demonstrated skill in the past do form portfolios with higher concentration levels. We conclude that talented asset managers should and actually do hold more concentrated portfolios and that the extent of this concentration decision is meaningfully related to forecasting skill.

Keywords: Portfolio Concentration, Manager Selection Skill, Forecast Accuracy

JEL Classification: G11, G17

Suggested Citation

Brown, Keith C. and Tiu, Cristian Ioan and Yoeli, Uzi, The Decision to Concentrate: Active Management, Manager Skill, and Portfolio Size (August 9, 2017). Available at SSRN: https://ssrn.com/abstract=3032200 or http://dx.doi.org/10.2139/ssrn.3032200

Keith C. Brown

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-471-6520 (Phone)
512-471-5073 (Fax)

Cristian Ioan Tiu (Contact Author)

University at Buffalo ( email )

238 Jacobs Management Center
Jacobs Hall, North Campus
Buffalo, NY NY 14260
United States
7166453299 (Phone)

TIAA Institute ( email )

8500 Andrew Carnegie Blvd
E3/S8
Charlotte, NC 28262
United States

Uzi Yoeli

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-471-1676 (Phone)

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