Too many managers in an asset class could hurt investment performance, according to a new article in the CFA Institute Financial Analysts Journal.
"My team meets with a lot of institutional investors across the globe, and we've been doing a number of research projects with clients doing a lot of risk analysis on their portfolios," said Ric Thomas, lead author as well as global head of strategy and research, investment solutions group, at State Street Global Advisors, Boston. "They've been overdiversified and it kept coming up over and over and over again."
The white paper, "What Free Lunch? The Costs of Overdiversification," examines how too many external managers can create enough of a loss of active risk that the overall active portfolio fails to outperform the benchmark.
The paper uses Pensions & Investments' data as of Sept. 30, 2015, utilizing the data of 88 of the top 200 U.S. defined benefit plans that provided complete manager data. According to the paper, plans on average utilize 75 external accounts.
The number of accounts vary by plan size: 16 plans with more than $50 billion in assets averaged 163 external accounts; 13 plans between $25 billion and $50 billion, 82 accounts; 39 plans between $10 billion and $25 billion, 56 accounts; 18 plans between $1 billion and $10 billion, 40 accounts; and two plans with less than $1 billion in assets, six accounts.
The paper was co-authored by Shawn McKay and Robert Shapiro, senior investment strategists in the investment solutions group at SSGA. State Street Global Advisors had $2.67 trillion in assets under management as of Sept. 30, $2.12 trillion of which was in passive strategies.
"We looked at the equity space just to keep it simple because there's a lot of asset classes that investors can allocate to," said Mr. Thomas. "We found that the average large pension fund — let's call it $1 billion and higher — allocates to between 12 to 30 active equity managers. That's the average.
"So we said if that's the average, what should be the right number and what does it mean for active risk? If you're north of 10 or 15 active equity managers, it's really hard to get active risk in your portfolio and you need some active risk to outperform," Mr. Thomas said.