Aurora Borealis
21 February 2018 Financial Analysts Journal Volume 74, Issue 1

What Free Lunch? The Costs of Overdiversification

  1. Shawn McKay, CFA
  2. Robert Shapiro, CFA
  3. Ric Thomas, CFA

Institutional investors, charged with outperforming a policy benchmark, often allocate to external active managers in order to hit their return objective. The challenge is to do so without overdiversifying the plan. Hiring too many managers can significantly reduce active risk, leaving the plan with high fees and limited ability to outperform a policy benchmark. We review the number of external investment strategies held by the largest US public and corporate pension funds. Our analysis shows that most large pension funds are overdiversified, allowing us to suggest a simpler framework for moving forward.

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