Optimal Number of Stock Holdings in Mutual Fund Portfolios Based on Market Performance

Abstract

Among the decisions that most mutual fund portfolio managers make is the number of stocks to hold. We posit that there is an optimal number of stocks for each mutual fund, reflecting the trade-off between diversification benefits versus transactions and monitoring costs. We find a significant quadratic relation between number of stock holdings and risk-adjusted returns for U.S. equity mutual fund portfolios during 1992–2000. Moreover, we find that changes in the number of stocks held over time are more highly correlated with mutual fund flows than with funds' investment returns.

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