How Diversified are Equity Mutual Funds?

The paper investigates the degree to which the domestic equity mutual fund is diversified, and attempts to determine the extent to which any undiversified idiosyncratic risk, i.e. unsystematic or company specific risk is associated with the average fund returns. The sample consists of mutual funds from six investment objective categories, including aggressive growth, small company, growth, growth and income, equity income, and index funds. The results show that, except for the index funds category, the average domestic fund is substantially undiversified. The average idiosyncratic volatility as a percentage of the fund's total volatility ranges from 0.82% for the index funds to 34.28% for the small company category. The explanatory power of the Fama-French-Carhart model declined during the 1986 to 2001 sub period, and then went back up from April 2001 to March 2006