tailieunhanh - In search of optimal number of bond funds

The simulation results show that three to five bond funds reduce standard deviation of terminal wealth by 50% and about 100 funds reduce the standard deviation by 90%. Given the annualized marginal cost of for bond funds, bond investors should hold three to five funds. However, equity investors who want to diversify need only one to two bond funds, regardless of risk measures. Holding more than two bond funds does not reduce portfolio risk much further especially for portfolios with high equity weights. The portfolios mixed with government and corporate bond funds require even fewer funds than the portfolios mixed with high yield bond funds. These results are robust to different investment strategies, holding periods and time periods and not subject to survivorship bias. These findings can be generalized to portfolios with other asset mixes. | Journal of Applied Finance Banking vol. 3 no. 1 2013 67-92 ISSN 1792-6580 print version 1792-6599 online Scienpress Ltd 2013 In Search of Optimal Number of Bond Funds Sirapat Polwitoon1 and Oranee Tawatnuntachai2 Abstract Although bonds are less volatile than equities and the median bond fund holds about 200 bonds bond investors still need to hold more than one bond fund to realize the optimal benefit of diversification. The simulation results show that three to five bond funds reduce standard deviation of terminal wealth by 50 and about 100 funds reduce the standard deviation by 90 . Given the annualized marginal cost of for bond funds bond investors should hold three to five funds. However equity investors who want to diversify need only one to two bond funds regardless of risk measures. Holding more than two bond funds does not reduce portfolio risk much further especially for portfolios with high equity weights. The portfolios mixed with government and corporate bond funds require even fewer funds than the portfolios mixed with high yield bond funds. These results are robust to different investment strategies holding periods and time periods and not subject to survivorship bias. These findings can be generalized to portfolios with other asset mixes. JEL classification numbers G10 G11 Keywords Bond diversification optimal bond portfolio terminal wealth 1 Introduction The most recent financial crisis underscores the importance of diversification. In 2008 investors who held financial stocks lost 55 of their portfolios on average while investors who diversified to S P 500 stocks lost 37 and those who added 40 bonds to their portfolios lost merely 18 . This anecdotal evidence clearly indicates that bonds a standard diversifier do provide the diversification benefits when needed. Concerning risk reduction thus bonds should be part of a well-diversified portfolio. Since mutual fund is 1 Sigmund Weis School of Business Susquehanna University. e-mail .