How Many Mutual Funds Do You Need to Create a Diversified Portfolio?

Abstract

The goals of this study are to examines diversification benefit when holding multiple equity funds in the portfolio for Thai market and identify the optimal number of equity funds that enough to eliminate diversifiable risk. Moreover, this study examines whether considering adding index funds in the portfolio better reduce portfolio volatility.

By creating random portfolio and measure the risks by using historical return, the empirical results suggest that holding multiple funds in the mutual fund portfolio allow investor achieve diversification benefits, but in the decreasing rate. These findings are consistent with previous study of O’Neal (1997), Potter (2001) and Lhabitant and Learned (2002) for U.S. market and Brands and Gallagher (2005) for Australian market. Additionally, the result from this study suggest that holding 13-14 funds is enough to eliminate diversifiable risk for Thai active equity fund portfolio, which is slightly more than U.S and Australian market. Also, considering including index funds in the equity fund portfolio can help slightly reduce portfolio volatility more than investing in only active funds.