Home-State Bias Problem for Funds

Mutual fund managers add to risk by overweighting stocks from home state, a study shows.

Mutual-fund managers who lack experience or resources tend to be swayed by a home state advantage, according to a new study from Indiana University’s Kelley School of Business.

While it’s common for portfolios to show a preference for nearby companies, it hasn’t been clear whether bias or a greater amount of information drives the predisposition toward investing in familiar companies, such as those headquartered in the manager’s home state. A forthcoming paper in the Review of Financial Studies, “No Place Like Home: Familiarity in Mutual Fund Manager Portfolio Choice,” is the first to document and quantify this bias among professional investors. The study by three Kelley School professors examined 42,109 quarterly fund observations for more than 2,000 funds.  

Fund managers overweighted stocks from their home state by 12% compared with stocks from other states, according to the paper, investing an estimated $31 billion per year based on familiarity. The bias increased among fund managers who had less experience, fewer resources or had spent more time in their home state.

Research shows that managers also tend to invest more in local companies, but those investments perform better than investments in other stocks, indicating that greater knowledge of the companies drives the selection. Managers who overweighted companies from their home state, rather than the city they reside in, did not see better results, indicating that superior knowledge did not drive the investment.

Home-state holdings underperformed the fund’s local holdings, but performed similarly to the rest of the portfolio, the study found. But it argues that an overweighting in home-state stocks creates excess risk, in part because it leads to a lack of diversity in the portfolio.

The most biased managers’ funds were underdiversified and inefficient. The study measured bias on a per-manager basis and found that for funds with multiple managers, the effect was amplified, creating portfolios with even greater overinvestment in home-state companies.

“We think that an implication is that investors may want to diversify across mutual funds,” says Noah Stoffman, a co-author of the study and an assistant professor of finance at the Kelley School. The results also seemed to indicate that there’s a benefit to investing with more experienced mutual-fund managers at larger companies, Stoffman says, since the bias was more pronounced among managers with less experience and fewer resources.  



Advertisement. Closing in 15 seconds.