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Performance Implications of Holding Multiple Mutual Funds with the Same Investment Objective

In this study we investigate the potential benefits of holding multiple mutual funds with the same fund objective. Given that a typical investor's asset allocation may involve multiple asset classes, we report results for an array of mutual fund types including aggressive growth, international equity, high quality bond, balanced, and tax-free money market funds. We measure the impact of holding multiple funds with the same investment objective on the standard deviation, mean shortfall, and semivariance of terminal wealth. Our results, which are reported for 5-year, 7-year, and 10-year holding periods, indicate that, with the exception of money market funds, it takes 5 to 6 mutual funds to reduce the variability of terminal wealth significantly regardless of fund objective. The finding for aggressive growth mutual funds is robust to controls for style differences. In other words, it still takes 5 to 6 mutual funds to diversify manager risk when we classify aggressive growth funds into small, large, value, and growth style groups. We find that the standard deviation of terminal wealth and the shortfall risk of holding a tax-free money market fund are very small in relation to the expected terminal wealth level. Thus, diversification is not a particularly relevant concern for this asset class. We also investigate how the performance of a portfolio of multiple funds in a given asset class compares with that of the benchmark portfolio for the asset class. We show that during our sample period of 1993-2002 on average aggressive growth and high quality bond funds underperform their benchmark market indices, and that holding multiple mutual funds with the same objective does not mitigate this underperformance problem. An important contribution of our study is its use of a sample that is free of survivorship bias.