Portfolio concentration and mutual fund performance- overconfidence or conviction?

PurposeThis paper investigates whether Indian equity mutual funds benefit from holding concentrated portfolios or whether such concentration reflects managerial overconfidence. It considers whether concentration signals genuine skill and conviction or excessive risk-taking, and explores how fund characterstics such as size, age, expenses, and fund flows are linked to varying degrees of concentration.Design/methodology/approachThe study covers 124 open-ended Indian equity mutual funds, using Morningstar Direct as the primary data source. Several concentration measures are employed, including number of holdings, weight of top ten stocks, stock- and industry-level concentration, idiosyncratic risk and a composite index developed through principal component analysis. Fund performance is evaluated using Jensen's Alpha, the Fama–French three-factor and Carhart four-factor models. Panel regressions examine the relationship between concentration and fund characteristics, followed by tests comparing the performance persistence of concentrated and diversified portfolios.FindingsThe results of the study reveal that smaller and younger funds are more likely to forgo frequent trading in favor of a few high-conviction positions. We also show that portfolio concentration in specific stocks or sectors is associated with stronger risk-adjusted performance, particularly when managers make bold active bets. Fund size and the level of net inflows emerge as the primary drivers of concentration decisions.Originality/valueThis research provides one of the earliest comprehensive examinations of portfolio concentration and fund performance in India. It contributes to the ongoing discussion on whether concentrated portfolios demonstrate informed conviction or overconfidence and offers valuable insights for investors, fund managers and market regulators.