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Say that you are a head of an investment fund. Your goal is to maximise the return on money entrusted to you by investing in various enterprises. You look to your left, and see another investment fund. This fund is doing the same thing as you, but better. They have an edge on you, and are getting higher returns. It seems an obvious strategy for your fund to just buy a stake in their fund. They can use the money better than you, it'll let you basically copy their homework and get better returns. So, my question is, why is it not in reality that all but one investment fund just invests in the leading fund? It seems inefficient.

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    $\begingroup$ Come to think of it, why is there more than one corporation in any industry/category? $\endgroup$
    – Giskard
    Commented Mar 12 at 13:10
  • $\begingroup$ Beats me. People aren't rational? $\endgroup$
    – Scott Rowe
    Commented Mar 17 at 2:27
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    $\begingroup$ @ScottRowe, there is antitrust and anti-monopoly regulation working against this. $\endgroup$ Commented Mar 17 at 16:10
  • $\begingroup$ I think someone said that necessary monopolies are not a problem, like water, sewer, electric, telephone, roads, etc. But really, why do we need more than one of most things, if they do a good job? The other options are worse, and not any cheaper. Right? $\endgroup$
    – Scott Rowe
    Commented Mar 17 at 21:43

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First, it is often hard to tell skill from luck. A fund that is leading today may be lagging tomorrow. Knowing that, investors may think twice before investing in a leading fund.

Second, not all investment strategies scale well. If a fund is great at picking stocks, it may invest into 10 best stocks. With more money, it invests in the 10 next best stocks*, but the latter are not as great as the first 10. And so on.

Third, different funds may have investments with different risk profiles. Different investors may be more averse to different types of risks, so they would choose the funds accordingly. E.g. if my main source of income is the oil sector, I may wish my investments to be concentrated elsewhere (or I may even wish to short the oil sector to some degree), as this offers better diversification of risk.


* Did they buy all outstanding share of the first 10 companies? Not necessarily. Buying too large a fraction of a stock tends to drive the stock price up, thereby reducing its future return and making this investment less attractive. Either way, the first-best option of investing just a bit in the best stocks without affecting their price has been exploited and is not available anymore. Thus, in terms of risk vs. return neither investing more in the original 10 stocks nor investing in the 10 next best stocks is as good as the original investment.

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    $\begingroup$ "it may invest into 10 best stocks. With more money, it invests in the 10 next best stocks" Did they buy all outstanding share of the first 10 companies?? $\endgroup$
    – Giskard
    Commented Mar 12 at 13:09
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    $\begingroup$ @Giskard, perhaps, but that seems unlikely in practice. Buying too large a fraction of a stock tends to drive the stock price up, thereby reducing its future return and making this investment less attractive. Either way, the first-best option of investing just a bit in the best stocks without affecting their price is gone, so investing more in the original 10 stocks or investing in the 10 next best stocks are both worse. $\endgroup$ Commented Mar 12 at 13:13
  • $\begingroup$ Indeed! It seems like your answer could be fleshed out in several places like this? $\endgroup$
    – Giskard
    Commented Mar 12 at 14:10
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    $\begingroup$ @Giskard, I agree; a great answer would be more detailed. The level of detail of mine reflects how much time I had available at the time of writing it. $\endgroup$ Commented Mar 12 at 14:52

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