Journal of Banking and Finance 123 (2021) 106033

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Journal of Banking and Finance

journal homepage: www.elsevier.com/locate/jbf

Does portfolio concentration affect performance? Evidence from

corporate bond mutual funds ✩
Nan Qin a, Ying Wang b,∗
a
College of Business, Northern Illinois University, Barsema Hall 236, 740 Garden Road, DeKalb, IL 60115, United States
b
School of Business and Center for Institutional Investment Management, State University of New York at Albany, 365 Massry Center for Business, Albany,
NY 12222, United States

a r t i c l e i n f o a b s t r a c t

Article history: This paper examines the relation between portfolio concentration and investment performance in cor-
Received 31 May 2019 porate bond mutual funds. Using detailed holdings data, we construct portfolio concentration measures
Accepted 14 December 2020
at the firm, industry, and credit rating levels. We find that portfolio concentration is significantly posi-
Available online 6 January 2021
tively related to expected abnormal returns of corporate bond funds, and this relation is mainly driven
Keywords: by investment-grade funds. High-yield funds, however, do not exhibit such a relation, possibly due to
Portfolio concentration the erosion of the value of portfolio concentration by liquidity costs. In support of this conjecture, we
Corporate bond fund performance document that the concentration-performance relation is less pronounced among funds with higher sen-
Fund holdings sitivities to market-wide illiquidity innovations and during periods of bond market illiquidity shocks and
Liquidity costs fund-level net money outflows. Finally, we show that more concentrated funds demonstrate stronger per-
Bond market illiquidity formance persistence, and investors appear to consider portfolio concentration in making investment de-
Performance persistence
cisions.
Published by Elsevier B.V.

1. Introduction
Do mutual fund managers create value by holding concentrated
portfolios? While this question has been well studied for equity
funds in the literature,1 little attention has thus far been paid to
the value of portfolio concentration in corporate bond funds de-
spite the increasingly important status they enjoy in investment
portfolios. For instance, according to 2020 Investment Company Fact
Book,2 the total assets under management by U.S. corporate bond
funds have substantially increased from $349 billion to $2.5 trillion
✩
We are grateful to Geert Bekaert (Managing Editor), an Associate Editor, three
anonymous referees, Anna Agapova, Yong Chen, Wayne Ferson, and conference
participants at the 2018 Financial Management Association Annual Meeting for
thoughtful comments and suggestions. Ying Wang gratefully acknowledges research
support from the Center for Institutional Investment Management (CIIM) at State
University of New York at Albany.
∗
Corresponding author.
E-mail address: ywang@albany.edu (Y. Wang).
1 3
The evidence on the relation between portfolio concentration and equity fund
performance is mixed. For instance, Coval and Moskowitz (2001), Kacperczyk et al.
(2005), and Choi et al. (2017) document that concentrated investment strategies
provide higher returns to U.S. and global equity funds, while Sapp and Yan (2008)
find that more concentrated U.S. equity funds underperform their less concentrated
counterparts.
2
Source: Investment Company Institute (https://www.ici.org/pdf/2020_factbook.
pdf).
during the 20 0 0 to 2019 period; by the end of 2019, these funds
account for 12% of total mutual fund assets, as compared to 40%
for U.S. domestic equity funds.
Anecdotal evidence suggests that bond fund managers often
hold concentrated portfolios to reflect their views of future market
conditions.3 However, to the best of our knowledge, no academic
research has studied whether corporate bond fund managers cre-
ate value by employing concentrated investment strategies. We fill
this gap by providing the first comprehensive empirical study of
the value of portfolio concentration in the corporate bond market.
Specifically, we examine whether fund managers generate supre-
rior performance by concentrating their corporate bond portfolios
in specific firms, industries, and credit categories.
Whereas the Modern Portfolio Theory predicts that diversified
portfolios are optimal (Markowitz, 1952), recent studies suggest
that fund managers could optimally build under-diversified port-
folios to exploit their information advantages.4 For instance,
See, for example, Mullaney (2017), where several top bond fund managers such
as Elaine Stokes of Loomis Sayles, Scott Mather of Pacific Investment Management
Company (PIMCO), Michael Collins and Robert Tipp of Prudential, and Rick Rieder of
BlackRock provide insights on how they use different portfolio concentration strate-
gies in light of the surging economic optimism.
4
The literature also suggests that equity fund managers might increase portfo-
lio concentration due to the potential agency conflict between managers and in-
vestors (see, e.g., Chevalier and Ellison, 1997; Sirri and Tufano, 1998; Kacperczyk

https://doi.org/10.1016/j.jbankfin.2020.106033
0378-4266/Published by Elsevier B.V.
N. Qin and Y. Wang
Levy and Livingston (1995) show that managers with su-
perior information should hold a relatively concentrated
portfolio in a mean-variance framework. Van Nieuwerburgh
and Veldkamp (2010) argue that investors who first col-
lect information can achieve optimal under-diversification.
Kacperczyk et al. (2005) show that skilled fund managers tend to
hold portfolios concentrated in a few industries where they have
information advantages.
Ex ante, however, it is not clear whether corporate bond fund
managers could generate value by holding more concentrated port-
folios due to the distinct features of the corporate bond market.
In particular, corporate bonds are usually characterized by much
lower liquidity and consequently higher trading costs compared to
equities, possibly due to the fact that the bond market is dom-
inated by buy-and-hold institutional investors such as insurance
companies and that bonds trade over-the-counter (OTC) so it is of-
ten difficult to find a counterparty. While concentrated portfolios
might provide opportunities for managers to exploit their informa-
tion advantages in the corporate bond market, they do not neces-
sarily outperform their diversified counterparts due to the poten-
tial liquidity costs arising from concentration.
Intuitively, fund managers are typically forced to liquidate as-
sets to meet daily investor redemptions, especially during unfa-
vorable market conditions. Such liquidation is particularly costly
for concentrated funds as it might incur significant downward
price pressure on the similar sets of securities that they hold and
thus result in significantly worse fund performance. This could
be of particular concern for corporate bond funds due to the
notoriously poor liquidity of their underlying assets. Moreover,
Goldstein et al. (2017) find that unlike equity funds that exhibit
a convex flow-performance relation, corporate bond funds show
greater sensitivity of outflows to bad performance than inflows to
good performance. As a result, concentration costs could be further
amplified by investment flows out of corporate bond funds follow-
ing bad performance.
Overall, the value of portfolio concentration in the corporate
bond market depends on its cost-benefit trade-off. We hypothesize
that portfolio concentration would lead to better fund performance
if it is a rational choice attributed to information advantage whose
benefits could outweigh its potential liquidity costs.
Using detailed holdings of a sample of 504 U.S. corporate bond
funds during July 2002-December 2017 from Morningstar, we first
construct portfolio concentration indices at the firm, industry, and
credit rating levels, respectively. We consider these dimensions be-
cause skilled fund managers may exhibit superior performance by
holding more concentrated portfolios to exploit their information
advantages of specific firms, industries, and credit categories.5
In general, we document the value of portfolio concentration
in the corporate bond market by showing that concentrated in-
vestment strategies are related to higher abnormal returns of cor-
porate bond funds for all three concentration indices under both
portfolio and regression analyses. The results are robust to the use
et al., 2005). Specifically, as investors tend to reward stellar performers with dis-
proportionately high money inflows while not penalizing poor performers equiv-
alently, equity fund managers, especially those with low investment skills, might
hold concentrated portfolios to increase the probability of being one of the top per-
formers. However, corporate bond funds are not subject to the same convex flow-
performance relation as equity funds (Chen and Qin, 2017; Goldstein et al., 2017),
so it is unlikely that fund managers’ motivations for holding concentrated corporate
bond portfolios are driven by their particular incentive structure.
5
In untabulated tests, we also examine if corporate bond fund managers could
increase duration concentration to exploit their information advantages of interest
rates, and find no significant relation between duration concentration and corporate
bond fund performance. This is not surprising as the literature suggests that bond
fund managers do not possess private information about interest rates (Huang and
Wang, 2014).
2
Journal of Banking and Finance 123 (2021) 106033
of alternative performance measures (i.e., pre- or post-fee alphas
estimated from both conditional and unconditional models, and
liquidity-risk-adjusted alphas). We also find that increased portfo-
lio concentration leads to better performance of the part of the
portfolio that only consists of corporate bonds, indicating that our
results are not driven by non-corporate-bond holdings or by return
smoothing of corporate bond funds (Cici et al., 2011). Further, we
show that the performance predictive power of portfolio concen-
tration can last as long as five quarters.
However, it is important to note that the positive relation
between portfolio concentration and future fund performance is
mainly driven by investment-grade (IG) funds. High-yield (HY)
funds, on the other hand, do not exhibit such a relation, possibly
because the value of portfolio concentration is largely eroded by
the high liquidity costs in these funds.
To shed further light on concentration costs, we examine the
effect of liquidity–captured by the sensitivity of fund’s underlying
positions to market-wide liquidity innovations (i.e., liquidity beta)–
on the relation between portfolio concentration and future fund
performance.6 We expect the relation between portfolio concentra-
tion and performance to be weaker among funds with higher liq-
uidity betas, and during periods of market illiquidity shocks when
the liquidity costs arising from concentration become more promi-
nent. Moreover, as liquidity is more likely to become a problem
when funds need to liquidate their positions in response to net
outflows, we expect the positive concentration-performance rela-
tion to be weaker during periods of net outflows.
Consistent with our hypotheses, we find that the positive
concentration-performance relation is weaker among funds with
higher liquidity betas and during periods of market illiquidity
shocks. This result is particularly strong for HY funds, suggest-
ing that the insignificant results for HY funds can be attributed
to liquidity. In addition, we show that the positive concentration-
performance relation exists even for HY funds when funds expe-
rience net inflow; however, this relation becomes mostly insignif-
icant when funds experience net outflows. These results suggest
that portfolio concentration might result in significant liquidity
costs, thus offsetting its potential information benefits.
Finally, we document that performance persistence is more pro-
nounced among more concentrated corporate bond funds, suggest-
ing that portfolio concentration is indicative of superior managerial
skills. We also show that the positive flow-performance relation is
stronger for funds with a higher degree of portfolio concentration,
implying that investors assign a greater weight to past fund returns
in their decision-making process for more concentrated funds. This
is probably because investors consider better past performance, in
conjunction with greater portfolio concentration, as a more accu-
rate signal of managerial skills.
We contribute to the existing literature in several aspects. First,
this study extends the literature on bond fund performance and
furthers our understanding of the value of active management
in the corporate bond market. Existing empirical evidence shows
that bond funds, on average, underperform benchmarks (see, e.g.,
Blake et al., 1993; Elton et al., 1995; Ferson et al., 2006; Huij and
6
To capture the effect of liquidity, we also consider portfolio-level illiquidity
measure, which is calculated as the value-weighted average of the Amihud (2002)
illiquidity measures of a fund’s underlying corporate bonds. However, this measure
might significantly understate the illiquidity level of the most illiquid corporate
bond funds, because the Amihud (2002) measures are likely missing due to lim-
ited trading frequency for most of the illiquid bonds held by these funds. Indeed,
we do not find significant differences in portfolio-level illiquidity measures between
IG and HY funds, possibly due to the bias in constructing such measures. Instead,
we show that HY funds exhibit significantly higher liquidity betas than IG funds. As
a result, we focus on fund-level liquidity betas instead of portfolio-level illiquidity
measures. We thank an anonymous referee for pointing out this bias and suggesting
the use of fund-level liquidity betas in lieu of portfolio-level illiquidity.
N. Qin and Y. Wang
Derwall, 2008). More recent studies also suggest that an average
bond fund has neutral market timing ability (see, e.g., Chen et al.,
2010; Boney et al., 2009; Cici and Gibson, 2012; Huang and
Wang, 2014; Moneta, 2015). Using fund returns data, Amihud and
Goyenko (2013) provide some preliminary evidence that active
management–measured by R2 –enhances corporate bond fund per-
formance. In contrast, using fund holdings data, we provide a more
comprehensive analysis of the value of active management as mea-
sured by portfolio concentration at the firm, industry, and credit
rating levels, respectively. More importantly, we discover a striking
difference between IG and HY funds: the positive concentration-
performance relation only exists in IG funds but not in HY funds,
possibly due to the higher liquidity costs incurred by more concen-
trated HY funds. Our paper thus offers additional insights relative
to Amihud and Goyenko (2013) in that the value of active man-
agement in the corporate bond market depends on the trade-off
between the benefits and costs of active investment strategies.
Second, this paper adds to our knowledge of the value of
portfolio concentration beyond what has been documented in
the equity literature. The existing literature has focused on port-
folio concentration and investment performance of institutional
and individual investors in the equity market, such as U.S. eq-
uity mutual funds (Coval and Moskowitz, 2001; Kacperczyk et al.,
2005; Sapp and Yan, 2008; Fulkerson and Riley, 2019), global
and foreign equity funds (Choi et al., 2017; Huij and Der-
wall, 2011; Fjesme, 2020), individual investors (Ivković et al., 2008;
Goetzmann and Kumar, 2008), and hedge funds (Titman and
Tiu, 2011; Sun et al., 2012). It remains an interesting empirical
question as to whether portfolio concentration leads to higher cor-
porate bond fund performance given the notoriously poor liquidity
of corporate bonds. We fill this gap by documenting the value of
portfolio concentration in corporate bond funds. Notably, we shed
further light on the potential liquidity costs by examining the ef-
fect of liquidity on the positive concentration-performance relation
in corproate bond funds. Our findings that this relation is signifi-
cantly weaker among funds with higher liquidity betas and during
periods of market illiquidity shocks and fund-level net money out-
flows are new to both the bond and equity fund literature, thus
furthering our understanding of the value of portfolio concentra-
tion in general.
Finally, the detailed holdings allow us to measure portfolio
concentration in different dimensions for corporate bond funds.
While the analysis of firm- and industry-level concentration in-
dices extends the existing literature on equity funds, the analysis
of credit rating concentration index provides a new perspective on
the unique concentration strategies of bond mutual funds. More-
over, our method of computing portfolio concentration is straight-
forward and can be applied to calculate portfolio concentration
across other dimensions.
The rest of the paper is organized as follows. Section 2 dis-
cusses our data and measures. Section 3 presents the empirical
results regarding the relation between portfolio concentration and
expected corporate bond fund performance. Section 4 concludes.
2. Data and measures
To construct our sample, we combine multiple datasets in this
paper, including (1) the Trade Reporting and Compliance Engine
(TRACE) Enhanced Bond Trades database which was first intro-
duced by National Association of Securities Dealers (NASD) in July
2002 for corporate bond prices, (2) the Mergent Fixed Income Se-
curities Database (FISD) for bond issue and issuer characteristics,
and (3) Morningstar for corporate bond mutual fund holdings as
well as fund returns and characteristics . Due to data availability,
our sample spans the period of July 2002 to December 2017.
3
Journal of Banking and Finance 123 (2021) 106033
2.1. Corporate bond sample
We obtain corporate bond data mainly from two sources: (1)
the TRACE Enhanced database, which provides real-time transac-
tion and price data of all publicly traded corporate bonds, and (2)
the Mergent FISD database, which provides bond issue and issuer
characteristics such as bond type, issue date, issue amount, amount
outstanding, coupon, interest payment frequency, maturity, provi-
sions, and credit ratings. The Standard Industrial Classification (SIC)
codes of bond issuers are primarily from the Center for Research in
Security Prices (CRSP) database and supplemented by FISD when
the information is otherwise unavailable.7
To construct our corporate bond sample, we first clean
the TRACE Enhanced database by eliminating canceled, cor-
rected, and reversed trades following Dick-Nielsen (2009) and
Dick-Nielsen (2014), and use median and reversal filters as in
Edwards et al. (2007) and Schestag et al. (2016) to remove extreme
outliers and apparently erroneous entries.8 We then merge TRACE
with the Mergent FISD database to obtain bond issue and issuer
characteristics. As we focus on U.S. corporate bonds, we exclude
non-U.S. dollar denominated bonds, convertible bonds, mortgage-
backed securities, asset-backed securities, agency securities, unit
deals, and preferred securities. We also remove variable rate bonds,
sinking fund bonds, private placement bonds, bonds with miss-
ing coupon or maturity date, and bonds with missing or irregu-
lar interest payment frequency. We further eliminate bonds with
no credit rating information or in default. Our sample includes
45,642 U.S. corporate bonds issued by 5,273 firms during July
2002-December 2017.
2.2. Data on corporate bond mutual funds
Our data on corporate bond mutual funds come from Morn-
ingstar, which provides detailed holdings information and fund re-
turns and characteristics for both surviving and dead funds. Al-
though funds were required by law to disclose holdings semian-
nually until May 2004 and quarterly thereafter, many funds vol-
untarily report portfolio holdings to Morningstar at a higher fre-
quency. Morningstar also reports Morningstar Category, inception
date, monthly returns, total net assets (TNA), and net flows, as
well as annual turnover rates and expense ratios. We obtain value-
weighted returns, turnover rates, and expense ratios across multi-
ple share classes of the same fund. Age of a fund is defined as the
number of years since the inception date of its oldest share class.
We also aggregate TNA and net fund flows across share classes for
each fund and then obtain monthly net fund flow ratios by divid-
ing net flows by TNA at the end of the previous month. Finally, we
calculate fund family size by aggregating fund assets at the family
level.
To construct our fund sample, we start with all U.S. bond mu-
tual funds in the Morningstar database during our sample period
of July 2002 to December 2017.9 We keep U.S. corporate bond
funds with the Morningstar Categories of “High Yield Bond,” “Long-
Term Bond,” “Intermediate-Term Bond,” “Short-Term Bond,” “Mul-
tisector Bond,” and “Corporate Bond,” and exclude government,
municipal, emerging markets, and foreign countries bond funds,
ultra-short bond funds, and passively managed funds. Next, we
combine multiple share classes of the same fund. Finally, we re-
quire a fund to hold a minimum average of 30% of its assets in cor-
7
While the CRSP data reflect possible changes of SIC codes over time for an is-
suing firm, this information is not provided by FISD.
8
We also correct a small number of erroneous entries with obviously misplaced
decimal points.
9
Data on fund monthly returns start from July 1999, as we need fund returns
over the prior 36 months to estimate fund alphas in regression analysis.
N. Qin and Y. Wang
porate bonds and further remove fund-month observations where
corporate bonds account for less than 30% of fund assets at the end
of the previous calendar quarter, fund size is less than $5 million
at the end of the previous month, or fund age is less than one year.
We define a fund as a high-yield (HY) bond fund if its Morningstar
Category is “High Yield Bond,” and as an investment-grade (IG)
bond fund otherwise. Our final sample consists of 504 unique U.S.
corporate bond funds, including 295 IG and 209 HY bond funds.
2.3. Portfolio concentration indices
We develop portfolio concentration indices at the firm, indus-
try, and credit rating levels, respectively, for our sample of corpo-
rate bond funds based on their holdings of corporate bonds, and
then discuss the benchmark portfolios used in constructing these
indices.
2.3.1. Firm-level concentration index
For each corporate bond fund, we define firm-level concentra-
tion index (CI_F irm) in a quarter as:
1 Nt
CI_F ir mi,t = |wi, j,t − w̄ j,t |, (1)
2 j=1
where Nt denotes the number of firms that issue corporate bonds
in quarter t, wi, j,t is the actual portfolio weight of bonds held by
fund i that are issued by firm j in quarter t, and w̄ j,t is the expected
portfolio allocation to bonds issued by firm j in quarter t, which is
proxied by the overall weight of all bonds issued by firm j in a
relevant benchmark portfolio.
The firm-level concentration index is similar to the active share
measure of Cremers and Petajisto (2009). It denotes the fraction of
a fund’s corporate bond portfolio that should be reallocated across
different firms to achieve perfect firm-level diversification as in a
relevant benchmark. This index is equal to zero if a corporate bond
fund has exactly the same firm compositions as the benchmark
portfolio and increases with the degree of portfolio concentration
in bond issuers.
2.3.2. Industry concentration index
To construct industry concentration index (CI_Ind) for corporate
bond funds, we first classify their underlying corporate bonds into
one of the 48 industries as defined in Fama and French (1997). We
then calculate CI_Ind of a fund in a quarter as follows:
1 48
CI_Indi,t = |wi, j,t − w̄ j,t |, (2)
2 j=1
wi, j,t where is the actual portfolio weight of all bonds held by fund
i in industry j in quarter t, and w̄ j,t is the expected industry allo-
cation calculated as the weight of all corporate bonds in industry j
in a relevant benchmark portfolio in quarter t.
Our measure is similar to the industry concentration index of
Kacperczyk et al. (2005), and can be directly interpreted as the
fraction of a fund’s corporate bond holdings that should be reallo-
cated across industries to achieve perfect industry diversification. A
measure of zero suggests that fund managers make portfolio allo-
cations to industries exactly in line with industries’ market capital-
ization weights in a benchmark portfolio. A measure greater than
zero indicates that the corporate bond portfolio is not perfectly di-
versified across industries.
2.3.3. Credit rating concentration index
We introduce a new measure of portfolio concentration for
corporate bond funds, namely credit rating concentration index
(CI_CR), to measure portfolio under-diversification across various
credit rating categories. Specifically, we sort all bonds into 20 cate-
gories by their credit ratings: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1,
4
Journal of Banking and Finance 123 (2021) 106033
Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, and Ca.10
We then measure CI_CR of a fund in a quarter as:
1
20
C I_C Ri,t = |wi, j,t − w̄ j,t |, (3)
2
j=1
where wi, j,t is the actual portfolio weight of bonds held by fund
i in credit rating category j in quarter t, and w̄ j,t is the expected
credit rating allocation as proxied by the overall weight of all cor-
porate bonds in credit rating category j in a relevant benchmark
portfolio in quarter t.
This concentration measure captures a new and unique dimen-
sion of under-diversification in the corporate bond market. Intu-
itively, as this measure increases, a fund’s corporate bond portfolio
becomes more concentrated in a few credit rating categories.
2.3.4. Benchmark portfolios
In constructing the above three concentration indices, we need
to identify the relevant benchmark portfolios for each corporate
bond fund. Ideally, we should use the different benchmarks that
individual funds specify in their prospectus to measure portfo-
lio concentration. Despite its intuitive appeal, this approach suf-
fers from the lack of benchmark holdings data. Alternatively, we
may follow Kacperczyk et al. (2005) and use a market portfolio
that consists of all corporate bonds in the market as a benchmark.
However, a possible criticism of this approach stems from the fact
that many corporate bond funds pursue specific investment ob-
jectives, which may lead to biases in the estimation of portfolio
concentration indices. For example, a long-term IG fund mechani-
cally has a high value of credit rating concentration index even if
the manager simply replicates the market of long-term IG corpo-
rate bonds. To reduce such biases, we construct the following nine
corporate bond benchmark portfolios in the spirit of Morningstar’s
3 × 3 fixed-income style box:11
1) Limited interest-rate sensitivity and high credit quality cor-
porate bonds;
2) Moderate interest-rate sensitivity and high credit quality
corporate bonds;
3) Extensive interest-rate sensitivity and high credit quality
corporate bonds;
4) Limited interest-rate sensitivity and medium credit quality
corporate bonds;
5) Moderate interest-rate sensitivity and medium credit quality
corporate bonds;
6) Extensive interest-rate sensitivity and medium credit quality
corporate bonds;
7) Limited interest-rate sensitivity and low credit quality cor-
porate bonds;
8) Moderate interest-rate sensitivity and low credit quality cor-
porate bonds;
9) Extensive interest-rate sensitivity and low credit quality cor-
porate bonds.
Following Morningstar, we classify corporate bonds according
to sensitivity to changes in interest rates and credit quality. Lim-
ited, moderate, and extensive interest-rate sensitivity refer to those
bonds with a duration of shorter than 3.5 years, between 3.5 and
6 years, and longer than 6 years, respectively; high, medium, and
low credit quality refer to those bonds with a credit rating of be-
tween Aaa and Aa3, between A1 and Baa3, and below Baa3, re-
10
We primarily use Moody’s ratings, and only use Standard & Poor’s (S&P) or Fitch
ratings in case of missing Moody’s ratings. Mainly using S&P ratings leads to similar
results.
11
For details of Morningstar’s fixed income style box, please refer to https://www.
morningstar.com/InvGlossary/morningstar_style_box.aspx.
N. Qin and Y. Wang
spectively. The minimum of the average concentration indices cal-
culated over quarters t-4 to t-1 (a minimum of one quarter is re-
quired) across the nine benchmark portfolios is used to determine
the fund’s style and calculate its concentration indices in quarter
t. For example, if the manager of a HY fund simply replicates the
market of intermediate-term, low-quality bonds, the credit rating
concentration index estimated using the benchmark portfolio (8)
above will be zero, while those estimated based on other bench-
mark portfolios will be greater than zero. Therefore, we should use
(8) as the benchmark portfolio in estimating the fund’s concentra-
tion index in the next quarter.
Our approach of selecting benchmark portfolios has several ad-
vantages. First, it circumvents the empirical challenge of insuffi-
cient benchmark holdings data. Second, we take into account time-
variation in investment styles of corporate bond funds, thus reduc-
ing biases in estimating portfolio concentration. Finally, it captures
not only managers’ security selection activities but also their mar-
ket timing activities. For example, if a manager attempting to time
the market shifts a completely diversified intermediate-term, high-
quality portfolio in quarter t-1 to a completely diversified long-
term, medium-quality portfolio in quarter t, (2) will be used as the
benchmark portfolio to estimate concentration indices in quarter t
and positive estimates will be obtained, despite that the minimum
of the concentration indices across the 9 benchmark portfolios in
quarter t is zero.
It is worth noting that our portfolio concentration indices
indeed capture the deviation of a fund portfolio from a particular
benchmark rather than the absolute level of concentration (such
as Herfindahl Index, a commonly accepted measure of concen-
tration). We choose benchmark-adjusted concentration measures
for two reasons. First, it is a standard approach to measure
portfolio concentration based on the deviation from a passive
benchmark portfolio in the literature (e.g., Kacperczyk et al., 2005;
Goetzmann and Kumar, 2008; Choi et al., 2017; Fjesme, 2020).
Second, this approach serves the intended purpose of examining
if managers’ active strategies of concentrating their portfolios in
certain assets are rewarded by positive abnormal returns. For ex-
ample, a portfolio manager may decide to overweight small bonds
and underweight large bonds relative to a passive benchmark.
This portfolio may have a lower absolute level of concentration
(e.g., Herfindahl Index) compared to the benchmark. However, it
is indeed more concentrated in small bonds than the benchmark
portfolio, reflecting the manager’s efforts to actively implement
a certain investment strategy. Thus, in that regard, it is more
appropriate to use benchmark-adjusted concentration measures.
2.4. Performance evaluation models
In this paper, we mainly use an unconditional four-factor model
in evaluating corporate bond fund performance. We also use a con-
ditional four-factor model for robustness tests.
2.4.1. Unconditional four-factor model
Following Elton et al. (1995) and Chen and Qin (2017), we use
an unconditional four-factor model to measure risk-adjusted per-
formance (alpha) of corporate bond funds:
Ri,t − R f,t = αi + βi,ST K ST Kt + βi,BOND BONDt + βi,DEF DE Ft
+βi,OPT ION OP T IONt + εi,t , (4)
whereRi is the return of fund i, R f is the risk-free rate, STK is the
excess return on the CRSP value-weighted stock index, BOND is the
excess return on the aggregate bond index, DEF is a return spread
between the long-term corporate and government bond indices,
and OPTION is the return spread between the GNMA mortgage-
backed security index and the intermediate government bond in-
dex. The OPTION factor is included to capture the fact that some
5
Journal of Banking and Finance 123 (2021) 106033
funds may hold securities with option-like features. Note that we
use Bloomberg Barclays bond indices.
2.4.2. Conditional four-factor model
As a robustness check, following Ferson and Schadt (1996), we
incorporate four macro variables into the performance evaluation
model in (4) to control for any impact of variations in market risk
levels and risk premium on corporate bond fund performance:
Ri,t − R f,t = αi + βi,ST K ST Kt + βi,BOND BONDt + βi,DEF DE Ft

4
+βi,OPT ION OP T IONt + βi,k (zk,t−1 BONDt ) + εi,t , (5)
k=1
where zk,t−1 is the demeaned value of one of the four macro vari-
ables used in Ilmanen (1995) and Huang and Wang (2014), includ-
ing (1) term spread (TERMSP), the difference between 10-year and
3-month Treasury yields; (2) real bond yield (RYLD), the difference
between 10-year bond yield and the one-month lagged year-on-
year inflation rate; (3) inverse relative wealth (IRW), a ratio of past
to current real wealth; and (4) bond beta (BETA), the regression
coefficient of excess long-term government bond returns against
excess stock market returns. Note that the first two variables rep-
resent the overall expected bond risk premium, while the last two
proxy for the time-varying risk aversion and time-varying risk, re-
spectively. The intercept αi measures conditional performance of a
corporate bond fund.
2.5. Liquidity measures
In our empirical analysis, we examine the relation between
portfolio concentration and fund performance conditional on
fund-level liquidity betas and aggregate bond market illiquidity
shocks. To construct the two conditional variables, we start with
two alternative estimates of bond-level illiquidity. First, follow-
ing Dick-Nielsen et al. (2012), among others, we construct the
Amihud (2002) illiquidity measure, which captures the price im-
pact of a trade per unit traded. Specifically, for each corporate
bond, we calculate its daily Amihud measure as:
Mt 1 N j,t |rk, j,t |
Amihud j,t = · , (6)
M1 N j,t k=1 Qk, j,t
where N j,t is the number of bond returns on day j in month t, Mt
is the total capitalization at the end of month t-1 of all bonds in-
cluded in the sample in month t, and rk, j,t and Qk, j,t are the return
and trade size (in million $) of the k-th bond trade on day j in
month t, respectively. Following Acharya and Pedersen (2005), we
scale the measure by Mt /M1 to make it stationary. Note that we re-
move retail trades of less than $10 0,0 0 0 in size as they are unlikely
to have a price impact (Trebbi and Xiao, 2017), and require a mini-
mum of two trades on a given day to calculate this measure. More-
over, following Acharya and Pedersen (2005), we cap the measure
at 30% per trade to ensure that our test results are not driven by
the extreme observations which are likely to be an artifact of low
volume. We then define a monthly Amihud measure as the median
of daily measures within the month.
Second, we follow Feldhütter (2012) and Dick-
Nielsen et al. (2012) and estimate an alternative measure of
transaction costs, i.e., the imputed roundtrip cost (IRC) based on
imputed roundtrip trades (IRT). For a given bond on a given day,
two or three trades with the same trade size are considered part
of an IRT if there are no other trades with the same size. We then
calculate IRC as:
Pmax − Pmin
IRC = , (7)
Pmax
where Pmax and Pmin are the highest and lowest prices in the IRT,
respectively. A daily estimate of IRC is the average of IRCs of all
N. Qin and Y. Wang Journal of Banking and Finance 123 (2021) 106033

Table 1
Summary Statistics of Corporate Bond Mutual Funds. The table reports summary statistics of our corporate bond mutual fund sample during July 2002-December 2017.
The sample includes all active U.S. corporate bond funds with minimum total net assets (TNA) of $5 million and a minimum 30% of TNA held in corporate bonds at the
end of the prior quarter. Panel A reports summary statistics of fund characteristics for all corporate bond mutual funds as well as investment-grade (IG) and high-yield
(HY) bond funds separately. TNA (in $ million) is the fund size; TO (in %) is annual turnover ratio; EXP (in %) is annual expense ratio; Age of a fund is defined as the
number of years since the inception of the fund’s oldest share class; Flow (in %) is the monthly net fund flow ratio; RET (in %) is the monthly fund pre-fee return; FS
(in $ million) is the fund family size; CI_Firm, CI_Ind, and CI_CR denote portfolio concentration indices at the firm, industry, and credit rating levels, respectively. Panel B
reports the correlation matrix of fund characteristics among all funds, where concentration indices are demeaned within the IG or HY fund group. ∗∗∗ , ∗∗ , and ∗ indicate
the significance levels at 1%, 5%, and 10%, respectively.

All Funds Investment-Grade Funds High-Yield Funds

Mean Median Std. Dev. Mean Median Std. Dev. Mean Median Std. Dev.

Panel A. Summary Statistics of Fund Characteristics

# of Funds 504 295 209
TNA ($ million) 1,195 306 3,067 1,144 228 3,518 1,244 424 2,371
TO (%) 80.11 58.16 105.21 80.23 52.10 86.97 78.72 63.32 95.40
EXP (%) 0.87 0.85 0.34 0.77 0.74 0.32 0.98 0.96 0.31
Age 14.91 12.88 10.27 15.07 14.19 9.37 14.81 11.90 11.08
Flow (%) 0.44 0.02 7.70 0.35 0.01 7.31 0.51 0.08 7.58
RET (%) 0.59 0.61 1.60 0.44 0.41 1.19 0.79 0.89 1.83
FS ($ billion) 99.91 27.50 244.40 87.20 16.12 243.76 112.46 39.15 241.37
CI_Firm (%) 76.72 77.16 10.32 80.24 81.03 8.91 73.08 72.39 10.42
CI_Ind (%) 29.58 27.56 10.10 30.81 29.37 9.90 28.47 26.14 10.14
CI_CR (%) 26.05 23.45 11.90 31.96 30.14 11.40 20.05 18.44 8.91
Panel B. Correlation Matrix
TO EXP Ln[Age] Flow RET Ln[FS] CI_Firm CI_Ind CI_CR
Ln[TNA] 0.00 -0.16∗ ∗ ∗ 0.40∗ ∗ ∗ 0.02∗ ∗ ∗ 0.02∗ ∗ ∗ 0.67∗ ∗ ∗ -0.43∗ ∗ ∗ -0.38∗ ∗ ∗ -0.14∗ ∗ ∗
TO -0.01∗ ∗ ∗ -0.08∗ ∗ ∗ 0.03∗ ∗ ∗ 0.01∗ ∗ 0.04∗ ∗ ∗ -0.01∗ -0.04∗ ∗ ∗ -0.01∗ ∗ ∗
EXP 0.08∗ ∗ ∗ -0.03∗ ∗ ∗ 0.06∗ ∗ ∗ -0.14∗ ∗ ∗ 0.23∗ ∗ ∗ 0.19∗ ∗ ∗ 0.06∗ ∗ ∗
Ln[Age] -0.12∗ ∗ ∗ -0.01∗ ∗ ∗ 0.22∗ ∗ ∗ -0.16∗ ∗ ∗ -0.16∗ ∗ ∗ -0.11∗ ∗ ∗
Flow 0.15∗ ∗ ∗ -0.01∗ ∗ 0.01∗ ∗ 0.02∗ ∗ ∗ 0.03∗ ∗ ∗
RET 0.01∗ ∗ -0.00∗ ∗ 0.00∗ ∗ 0.01∗ ∗
Ln[FS] -0.45∗ ∗ ∗ -0.42∗ ∗ ∗ -0.20∗ ∗ ∗
CI_Firm 0.79∗ ∗ ∗ 0.47∗ ∗ ∗
CI_Ind 0.49∗ ∗ ∗

IRTs on that day, and a monthly estimate of IRC is the average of
daily measures within the month. Again, we cap this measure at
30% per trade to ensure that our test results are not driven by the
extreme observations as a result of misidentification of IRTs.
We next calculate market-wide illiquidity, MILLIQ, as the av-
erage of the Amihud or IRC illiquidity measures.12 Similar to
Lin et al. (2011), we estimate aggregate bond market illiquidity
shocks as innovations from the following time series regression:
MILLIQt = α0 + ϕ1 MILLIQt−1 + ϕ2 MILLIQt−1
+εt + θ1 εt−1 + θ2 εt−2 , (8)
where MILLIQt is the difference in monthly aggregate illiquid-
ity.13 The negative of innovation series εt becomes the market liq-
uidity factor, Lt , based on either the Amihud or IRC measure.
Finally, we add the liquidity factor to (4) and estimate fund-
level liquidity beta.(βi,L ) using monthly fund returns over the pre-
vious 36 months:
Ri,t − R f,t = αi + βi,ST K ST Kt + βi,BOND BONDt + βi,DEF DE Ft
+βi,OPT ION OP T IONt + βi,L Lt + εi,t . (9)
2.6. Summary statistics
Panel A of Table 1 reports summary statistics of fund charac-
teristics for our sample corporate bond funds as well as IG and
12
Following Schestag et al. (2016), we remove bonds with a history of less than a
year in TRACE and bonds with less than three months before default dates. We also
require a minimum bond size of $5 million to mitigate the influence of micro-cap
bonds on the market illiquidity measure.
13
Lin et al. (2011) also includes two dummy variables indicating March 2003 and
October 2004, respectively, as the level of illiquidity aggregated across individual
bonds shifts in March 2003 and October 2004 (i.e., TRACE implementation phases II
and III, respectively). The reason is that a substantial proportion of the bonds newly
included in the standard TRACE database in these two months have small issuance
size and low trading volume. However, the TRACE Enhanced database used in this
HY funds separately. On average, a corporate bond fund has TNA
of $1,195 million, a turnover rate of 80%, an expense ratio of 0.87%,
an age of 15 years, monthly flow of 0.44%, monthly return of 0.59%,
and family size of $100 billion. Moreover, the firm-level concentra-
tion index has an average value of 76.7%, indicating that corporate
bond funds on average are highly concentrated at the firm level.
In contrast, the average industry concentration (credit rating) in-
dex is 29.6% (26.1%), suggesting that no more than 29.6% (26.1%)
of the fund’s corporate bond holdings should be reallocated across
industries (credit rating categories) to achieve perfect diversifica-
tion relative to a benchmark. The table also shows that IG funds,
on average, have lower expense ratios, lower flows, lower pre-fee
raw returns, and smaller family size than HY funds. In addition,
IG funds have relatively higher portfolio concentration indices at
the firm, industry, and credit rating levels compared to HY funds.
Therefore, we demean the three concentration indices within the
IG or HY fund category for the rest of the paper to control for fund
styles so that we do not just capture the difference between IG and
HY funds.
Panel B of Table 1 reports correlation matrix among fund char-
acteristics. The results show that firm-level, industry, and credit
rating concentration indices are significantly positively related to
each other with correlation coefficients ranging from 0.47 to 0.79.
In addition, consistent with Kacperczyk et al. (2005), all three con-
centration indices are negatively related to fund size, age, and fam-
ily size, and positively related to expense ratio. The results are not
surprising given that larger and older corporate bond funds be-
longing to bigger families naturally have more room for diversifi-
cation. Moreover, more concentrated funds tend to charge higher
expenses, possibly to extract rents from their investment skills
(Berk and Green, 2004). Finally, we note that pre-fee fund raw
paper is not subject to this issue. Therefore, following Chung et al. (2019), we do
not include these two dummy variables.

6
N. Qin and Y. Wang Journal of Banking and Finance 123 (2021) 106033

Table 2
Corporate Bond Fund Portfolio Compositions. The table reports portfolio compositions for our sample of corporate bond mutual funds as well as investment-grade and
high-yield bond funds separately during July 2002-December 2017. The sample includes all active U.S. corporate bond funds with minimum total net assets (TNA) of $5
million and a minimum 30% of TNA held in corporate bonds at the end of the prior quarter. Panel A reports the average general portfolio compositions in percentage.
Panel B shows the average portfolio compositions in percentage by credit rating categories within the corporate bond portion of the portfolios.

All Funds Investment-Grade Funds High-Yield Funds

Panel A: General portfolio composition (in %)

Corporate Bonds 61.88 50.70 74.90
U.S. Government Bonds 5.79 10.27 0.40
Foreign Corporate Bonds 8.18 7.12 9.45
Foreign Government Bonds 0.84 1.29 0.31
Municipal Bond 0.75 1.30 0.06
Convertible Bonds 0.89 0.46 1.40
Asset-Backed Bonds 12.06 21.43 1.24
Unindentified Bonds 1.53 0.88 2.21
Common Stocks 0.67 0.27 1.14
Preferred Stocks 0.88 0.73 1.07
Cash and Cash equivalents 3.80 3.40 4.32
Others 2.73 2.14 3.50
Panel B: Corporate bond composition by credit rating categories (%)
AAA 1.08 2.06 0.01
AA 4.64 8.78 0.02
A 16.19 29.82 0.22
BBB 25.46 44.03 2.92
BB 18.43 8.51 30.18
B 24.89 4.39 49.22
Below B 7.95 1.15 16.03
Not Rated 1.36 1.26 1.41

returns are negatively related to firm-level concentration index,
while being positively related to industry and credit rating concen-
tration indices. However, the correlation coefficients between pre-
fee raw returns and the three concentration indices are all close to
zero. We further address this issue in Section 3.1.1.
Table 2 reports general portfolio compositions and corporate
bond compositions by credit rating categories in Panels A and B,
respectively, for our corporate bond fund sample. The table indi-
cates that corporate bond funds on average invest 62% of their
TNA in corporate bonds. However, while this ratio is 75% for HY
funds, it is only 51% for IG funds. In addition, IG and HY bonds
each account for roughly a half of all corporate bonds held by
an average corporate bond fund. Not surprisingly, IG (HY) bond
funds invest 85% (97%) of their corporate bond portfolios in IG (HY)
bonds.
3. Empirical analysis
In this section, we first examine the relation between portfo-
lio concentration and expected corporate bond mutual fund per-
formance. Next, we examine the effect of liquidity by investigating
the concentration-performance relation conditional on fund-level
liquidity betas and aggregate bond market illiquidity shocks, as
well as during periods of net fund-level inflows and outflows sep-
arately. We further investigate whether more concentrated funds
show stronger performance persistence and whether investors are
aware of the relation between concentration and fund performance
and allocate their money accordingly. Finally, we provide several
robustness tests.
3.1. Portfolio concentration and corporate bond fund performance
3.1.1. Baseline portfolio analysis
In the baseline portfolio analysis, each quarter we sort funds
into equal-weighted quintile portfolios based on their portfolio
concentration indices (demeaned within the IG or HY fund cat-
egory) at the end of the previous quarter at the firm, industry,
and credit rating levels, respectively. We then obtain both pre- and
post-fee monthly returns of these quintile portfolios and estimate
their risk-adjusted performance (alphas) using the unconditional
four-factor model in Eq. (4). Note that while post-fee alphas mea-
sure whether fund managers add value for investors, pre-fee alphas
evaluate the investment skills of managers who may charge high
expenses to extract rents (Berk and Green, 2004). We also report
the differences in alphas between the most concentrated (Quintile
5) and diversified (Quintile 1) portfolios as well as the associated
Newey-West adjusted t-statistics.
Panel A of Table 3 reports portfolio results for all corporate
bond funds. Based on pre-fee alphas (Columns 1-3), we find that
portfolio concentration is significantly positively associated with
future corporate bond fund performance. For example, based on
firm-level concentration index, the most concentrated portfolio
generates a pre-fee alpha of 14 basis points (bps) per month, while
the most diversified portfolio has a pre-fee alpha of 6 bps per
month. The difference between these two portfolios is 8 bps per
month, or 96 bps per annum, which is statistically significant at
the 1% level with a t-statistic of 3.30. Similarly, the difference in
pre-fee alphas between the portfolios with the highest and low-
est industry (credit rating) concentration indices is 7 bps (6 bps)
per month, or 84 bps (72 bps) per annum, again statistically sig-
nificant at the 1% level. Indeed, for all three concentration indices,
the pre-fee alphas of the most concentrated portfolios are all sig-
nificantly positive, while those of the least concentrated portfolios
are insignificant. The evidence indicates that managers of the most
concentrated corporate bond funds demonstrate significant posi-
tive investment skills, while those of the least concentrated funds
are perhaps quasi-indexers who tend to invest passively.
The results based on post-fee alphas (Columns 4-6) are simi-
lar to those using pre-fee alphas. For instance, the most concen-
trated portfolios significantly outperform the most diversified port-
folios by 6, 5, and 5 bps per month after expenses based on the
firm-level, industry, and credit rating concentration indices, respec-
tively. This result indicates that compared to their diversified coun-
terparts, concentrated corporate bond funds generally add more
value for their investors. In addition, we can see that the significant
positive pre-fee performance generated by the most concentrated
portfolios turns insignificant after deducting fees and expenses,
suggesting that these portfolios appear to have skilled managers
who capture rents from their alpha-generating ability (Berk and
Green, 2004).

7
N. Qin and Y. Wang Journal of Banking and Finance 123 (2021) 106033

Table 3
Corporate Bond Fund Performance Sorted by Portfolio Concentration. The table reports corporate bond fund abnormal returns sorted by portfolio concentration during July
2002-December 2017. Panels A, B, and C show results based on all, investment-grade (IG), and high-yield (HY) corporate bond mutual funds, respectively. Each quarter we
sort funds into equal-weighted quintile portfolios based on their portfolio concentration indices (demeaned within the IG or HY fund category) measured at the end of
the previous calendar quarter at the firm (CI_Firm), industry (CI_Ind), and credit rating (CI_CR) levels, respectively. We then obtain monthly returns of these portfolios and
calculate unconditional four-factor alphas as well as the differences in alphas between the most concentrated and diversified quintiles (5-1). Columns 1-3 and 4-6 show
results based on pre- and post-fee alphas, respectively. The Newey-West adjusted t-statistics are shown in parentheses. ∗∗∗ , ∗∗ , and ∗ indicate the significance levels at 1%,
5%, and 10%, respectively.

Pre-fee Alphas Post-fee Alphas

[1] [2] [3] [4] [5] [6]

CI_Firm CI_Ind CI_CR CI_Firm CI_Ind CI_CR

Panel A. All Funds

1 (Low) 0.06 0.06 0.05 -0.00 -0.00 -0.01
(0.75) (0.85) (0.88) (-0.03) (-0.02) (-0.21)
2 0.09 0.07 0.07 0.02 -0.00 -0.00
(1.31) (0.77) (0.79) (0.29) (-0.01) (-0.04)
3 0.03 0.05 0.09 -0.04 -0.02 0.02
(0.36) (0.55) (1.00) (-0.40) (-0.22) (0.21)
4 0.09 0.10 0.08 0.02 0.03 0.01
(1.48) (1.55) (1.09) (0.29) (0.41) (0.14)
5 (High) 0.14∗ 0.13∗ ∗ 0.11∗ ∗ 0.06 0.05 0.04
(1.94) (2.40) (2.06) (0.79) (0.95) (0.75)
5-1 0.08∗ ∗ ∗ 0.07∗ ∗ ∗ 0.06∗ ∗ ∗ 0.06∗ ∗ 0.05∗ ∗ 0.05∗ ∗
(3.30) (2.64) (2.80) (2.50) (2.02) (2.47)
Panel B. Investment-Grade Funds
1 (Low) -0.02 -0.03 0.00 -0.07 -0.08 -0.06
(-0.42) (-0.49) (0.01) (-1.28) (-1.40) (-1.31)
2 0.01 -0.04 0.01 -0.04 -0.10 -0.05
(0.43) (-0.60) (0.19) (-1.33) (-1.40) (-1.11)
3 0.04 0.08∗ ∗ ∗ 0.03 -0.02 0.02 -0.03
(1.13) (3.42) (0.76) (-0.54) (0.71) (-0.88)
4 0.04 0.07∗ ∗ ∗ 0.01 -0.03 0.00 -0.05
(0.89) (2.62) (0.25) (-0.67) (0.13) (-0.98)
5 (High) 0.10∗ ∗ ∗ 0.10∗ ∗ ∗ 0.12∗ ∗ ∗ 0.03 0.02 0.05∗ ∗
(4.27) (4.49) (5.10) (1.10) (1.01) (2.29)
5-1 0.13∗ ∗ 0.13∗ ∗ 0.12∗ ∗ 0.10∗ 0.10∗ ∗ 0.12∗ ∗
(2.38) (2.55) (2.23) (1.88) (2.11) (2.11)
Panel C. High-Yield Funds
1 (Low) 0.18∗ 0.19∗ ∗ 0.20∗ ∗ 0.10 0.11 0.12
(1.92) (1.97) (2.07) (1.11) (1.19) (1.25)
2 0.17∗ 0.20∗ ∗ 0.17∗ 0.10 0.12 0.09
(1.76) (2.22) (1.82) (0.98) (1.37) (0.99)
3 0.19∗ ∗ 0.18∗ ∗ 0.18∗ 0.11 0.10 0.10
(2.11) (1.98) (1.85) (1.25) (1.10) (1.05)
4 0.21∗ ∗ 0.19∗ 0.18∗ ∗ 0.13 0.11 0.11
(2.40) (1.92) (2.08) (1.48) (1.08) (1.20)
5 (High) 0.22∗ ∗ 0.21∗ ∗ 0.23∗ ∗ ∗ 0.13 0.13 0.15∗
(2.25) (2.35) (2.61) (1.35) (1.42) (1.69)
5-1 0.04∗ 0.03 0.03 0.03 0.02 0.03
(1.80) (1.32) (1.25) (1.25) (0.79) (1.12)

Panels B and C of Table 3 report portfolio results for IG
and HY bond funds, respectively. Interestingly, we find that the
documented significant positive relation between portfolio con-
centration and fund performance is mainly driven by IG funds.
For instance, based on pre- (post-) fee alphas, the most concen-
trated IG funds significantly outperform their most diversified
counterparts by 13, 13, and 12 (10, 10, and 12) bps per month,
respectively, in terms of firm-level, industry, and credit rating
concentration indices.
In contrast, there exist no significant differences in pre- or post-
fee alphas between the most and least concentrated HY funds for
all concentration indices except in the case of the firm-level in-
dex where the difference in pre-fee alpha is marginally significant
at the 10% level. The results suggest that increased portfolio con-
centration, in general, does not lead to higher performance of HY
funds, possibly because the high liquidity costs arising from con-
centrated portfolios largely offset the value of portfolio concentra-
tion among these funds. Indeed, HY funds appear to be more sen-
sitive to bond market illiquidity shocks compared to IG funds. For
instance, based on the Amihud measure, HY funds on average have
a much higher liquidity beta than IG funds (0.83 vs. 0.25) and the
difference is statistically significant with a t-statistic of 4.87. Sim-
ilarly, based on the IRC measure, the difference in liquidity betas
between HY and IG funds is 0.38 with a t-statistic of 4.55.
In general, the baseline portfolio results provide strong sup-
port for the value of portfolio concentration in the corporate bond
market. We show that portfolio concentration is significantly posi-
tively associated with future corporate bond fund performance us-
ing both pre- and post-fee alphas, suggesting that this relation can-
not be attributed to the different expense ratios charged by these
funds.14 It is important to note, however, that while this result
holds for IG funds, it does not generally hold for HY funds, pos-
sibly due to the high liquidity costs arising from concentrated HY
portfolios.
It is also worth noting that in Panel B of Table 1, pre-fee
fund raw returns are negatively (positively) correlated with
the firm-level (industry or credit rating) concentration index,
though the magnitude of correlations is close to zero for all three
14
To save space, we only report results based on pre-fee alphas in the following
analyses.

8
N. Qin and Y. Wang
concentration indices. As an adiditonal test, we conduct our
portfolio analysis using fund raw returns. The results reported in
Table A1 show that the difference in pre-fee raw returns between
the most concentrated and diversified quintile portfolios is sig-
nificantly positive only for credit rating concentration index, but
insignificant for firm-level and industry concentration indices.
To reconcile the difference between raw and risk-adjusted re-
turns, we further examine the factor loadings of quintile portfolios
using the four-factor model in Eq. (4). The results based on pre-
fee returns in Table A2 show that, relative to their most diversified
counterparts, the most concentrated portfolios have significantly
lower loadings on the BOND factor across all three concentration
indices and the DEF factor in the case of firm-level and industry
concentration indices.15 Therefore, while we find no significant re-
sults using raw returns (except in the case of credit rating concen-
tration index), we document a significant positive relation between
concentration and risk-adjusted returns for all three concentration
indices. These contrasting findings are largely driven by the signif-
icant differences in factor loadings between concentrated and di-
versified funds. To ensure that our results do not just reflect the
lower risk exposures of more concentrated portfolios, we mainly
rely on risk-adjusted returns in our analyses.
3.1.2. Regression analysis
The outperformance of concentrated corporate bond funds rel-
ative to their diversified counterparts could be due to the fact that
the portfolio approach fails to control for other fund characteristics
that are corrected with both portfolio concentration and expected
fund performance. For instance, as shown in Panel B of Table 1,
the three concentration indices are significantly negatively related
to fund size, age, and family size. Thus, it is possible that concen-
trated funds tend to outperform their diversified counterparts sim-
ply because they are smaller or younger, or belong to smaller fund
families. To ensure that our results are not driven by the omission
of other fund characteristics, we implement a panel regression ap-
proach.
Specifically, each month we use the past three years of monthly
corporate bond fund returns to estimate the unconditional four-
factor model in Eq. (4), and then calculate the abnormal returns
(AR ) of a fund as the differences between realized and expected
returns. Next, we run a panel regression of abnormal returns on
portfolio concentration, controlling for various fund characteristics,
as follows:
ARi,t = α + β C Ii,t−1 + γ Xi,t−1 + εi,t , (10)
where CI is one of the three concentration indices estimated at
the end of the previous quarter and demeaned within the IG or
HY fund category, and X is a vector of control variables includ-
ing lagged expense ratio (EXP), turnover rate (TO), fund age (Age),
total net assets (TNA), family size (FS), and net flow ratio (Flow).
We take the natural logarithm of age, size, and family size to re-
duce positive skewness, and control for benchmark-by-time fixed
effects to ensure that our regression would measure whether the
funds that have higher concentration perform better when com-
pared with other funds that are matched to the same benchmark
at any given time. As fund returns are likely to correlate with each
15
We further find that the lower factor loadings are a result of lower risk ex-
posure rather than a manifestation of estimation biases. For instance, we find that
more concentrated funds indeed have significantly lower return volatilities. Thus, it
is unlikely that the result relating abnormal returns and portfolio concentration is
driven by the fact that betas are measured more imprecisely (and thus downward
biased) for funds that are highly concentrated. We also find that more concentrated
funds on average hold bonds with significantly lower loadings on the BOND and
DEF factors, and these bonds on average have shorter maturities and durations. In
other words, when concentration is measured at the firm and industry levels, more
concentrated funds indeed on average have lower risk exposures.
9
Journal of Banking and Finance 123 (2021) 106033
other and across time, we also use standard errors clustered by
fund and time.
Table 4 reports regression results based on pre-fee abnormal re-
turns. Consistent with portfolio results in Table 3, the coefficients
on CI for all corporate bond funds (Columns 1-3) are significantly
positive at the 1% or 5% level with t-statistics of 3.08, 2.58, and
2.44, respectively, for firm-level, industry, and credit rating concen-
tration indices. These coefficients are also economically significant.
For example, a one-standard-deviation increase in the firm-level,
industry, and credit rating concentration indices improves the pre-
fee alpha of a corporate bond fund by 2.2, 1.9, and 2 bps per
month, respectively.
The coefficients on other fund characteristics are also worth
noting. For instance, the results show that fund performance is sig-
nificantly positively related to turnover, indicating that funds make
more when they trade more (Pastor et al., 2017). In addition, con-
sistent with Chen et al. (2004), we find a weak positive relation
between the performance of a corporate bond fund and the size
of the family to which it belongs, possibly due to the general re-
source and information advantages enjoyed by large fund families
(e.g., they could extensively invest in research, buy proprietary re-
search, and have access to management at conferences).
When examining IG (Columns 4-6) and HY (Columns 7-9) funds
separately, we note that only IG funds show a significant positive
relation between portfolio concentration and fund performance,
again consistent with portfolio results in Table 3. For example, the
coefficients on the three concentration indices are all positive and
significant at the 1% or 5% level for IG funds, whereas none of
these coefficients are significant for HY funds.
Overall, the regression results suggest that the documented sig-
nificant positive relation between portfolio concentration and fu-
ture corporate bond fund performance is not due to the omission
of other fund characteristics in the portfolio analysis. Further, this
relation is mainly driven by IG funds, again confirming the previ-
ous portfolio results.
3.1.3. Long-run predictability of portfolio concentration
In the baseline analysis, we document that portfolio concentra-
tion can predict corporate bond fund performance at the quarterly
horizon. It is natural to ask whether the performance predictive
power of portfolio concentration exists in the longer horizons. To
answer this question, we sort funds into equal-weighted quintile
portfolios in each quarter based on one of the three concentration
indices (demeaned within the IG or HY fund category) measured
at the end of the nth quarter prior, with n ranging from one to
eight. We then obtain pre-fee monthly returns of these portfolios
and calculate their monthly alphas using the unconditional four-
factor model in Eq. (4). For brevity, we only report the differences
in alpha between the most concentrated and diversified quintiles
and the associated Newey-West t-statistics in Table 5.
Panel A shows that the performance predictive power of all
three concentration indices lasts as long as five quarters for all
corporate bond funds. Panels B and C show results for IG and
HY funds, respectively. Consistent with the results reported in
Tables 3 and 4, the performance predictive power of portfolio
concentration is much stronger for IG funds and lasts up to eight
quarters. For HY funds, however, there exists almost no predictive
power of any of the three concentration indices. Overall, the evi-
dence suggests that the performance predictive power of portfolio
concentration is long-lasting for corporate bond funds, but this
result again is mainly driven by IG bond funds. As discussed
previously, these findings could again be due to the high liquidity
costs of concentrated HY funds. We further explore this possibility
in Section 3.2.
N. Qin and Y. Wang Journal of Banking and Finance 123 (2021) 106033

Table 4
Regression Analysis of Corporate Bond Fund Performance on Portfolio Concentration. The table reports regression results of corporate bond fund performance on portfolio
concentration, controlling for various fund characteristics, during July 2002-December 2017. Columns 1-3, 4-6, and 7-9 show results based on all, investment-grade (IG),
and high-yield (HY) corporate bond mutual funds, respectively. The dependent variable is the monthly fitted pre-fee abnormal returns estimated as the differences between
realized pre-fee returns and returns predicted by fund factor loadings and the realizations of the factors, where factor loadings are estimated based on the unconditional
four-factor model using pre-fee returns over the previous 36 months. Concentration Index (CI) is measured at the end of the previous quarter at the firm (CI_Firm), industry
(CI_Ind), and credit rating (CI_CR) levels, respectively, and demeaned within the IG or HY fund category. Other controlled fund characteristics include lagged expense ratio
(EXP), turnover rate (TO), the natural logarithm of fund age (Ln[Age]), total net assets (Ln[TNA]), and fund family size (Ln[FS]), and net flow ratio (Flow). We control for
benchmark-by-time (B × T) fixed effects in all regressions and report t-statistics (in parentheses) based on standard errors clustered by fund and time. ∗∗∗ , ∗∗ , and ∗ indicate
the significance levels at 1%, 5%, and 10%, respectively.

All Funds Investment-Grade Funds High-Yield Funds

[1] [2] [3] [4] [5] [6] [7] [8] [9]

CI_Firm CI_Ind CI_CR CI_Firm CI_Ind CI_CR CI_Firm CI_Ind CI_CR

Intercept 0.04 0.03 0.08∗ ∗ -0.16∗ ∗ -0.05 -0.00 -0.00 0.02 0.04
(1.13) (0.90) (2.13) (-2.18) (-1.13) (-0.01) (-0.02) (0.31) (0.48)
CI 0.21∗ ∗ ∗ 0.19∗ ∗ 0.17∗ ∗ 0.20∗ ∗ ∗ 0.15∗ ∗ 0.15∗ ∗ ∗ 0.10 0.09 0.11
(3.08) (2.58) (2.44) (2.72) (2.36) (3.01) (0.97) (0.56) (0.45)
EXP 1.74 2.20 1.11 0.94 1.32 0.56 2.60 3.41 2.68
(0.86) (1.13) (0.56) (0.57) (0.70) (0.29) (0.62) (0.77) (0.60)
TO 0.02∗ ∗ ∗ 0.02∗ ∗ ∗ 0.02∗ ∗ ∗ 0.01∗ 0.01∗ ∗ 0.01 0.03∗ ∗ ∗ 0.04∗ ∗ ∗ 0.03∗ ∗ ∗
(3.14) (3.33) (2.71) (1.73) (1.98) (1.42) (3.01) (3.70) (3.48)
Ln[Age] -0.00 -0.00 0.00 0.00 0.00 0.00 -0.00 -0.01 -0.00
(-0.63) (-0.57) (0.01) (0.38) (0.33) (0.44) (-0.38) (-0.60) (-0.01)
Ln[TNA] 0.00 0.00 0.00 0.00 0.00 -0.00 0.01 0.01 0.01
(0.96) (1.08) (0.10) (0.60) (0.75) (-0.30) (0.95) (0.96) (0.86)
Ln[FS] 0.00∗ 0.00∗ 0.00 0.00 0.00 -0.00 0.01 0.01 0.01
(1.95) (1.70) (0.69) (1.23) (0.77) (-0.10) (0.90) (1.12) (0.89)
Flow -0.03 -0.05 -0.00 0.14 0.13 0.14 -0.09 -0.17 -0.06
(-0.22) (-0.29) (-0.02) (1.35) (0.96) (1.22) (-0.35) (-0.67) (-0.27)
B × T Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.740 0.740 0.740 0.410 0.370 0.330 0.820 0.810 0.810
N 38,926 38,926 38,888 20,287 20,227 20,157 18,568 18,470 18,547

Table 5
Long-run Predictability of Portfolio Concentration. The table examines the long-run predictability of portfolio concentration for corporate bond fund performance during
July 2002-December 2017. Panels A, B, and C show results based on all, investment-grade (IG), and high-yield (HY) corporate bond mutual funds, respectively. Each quarter
we sort funds into equal-weighted quintile portfolios based on their portfolio concentration indices (demeaned within the IG or HY fund category) at the firm (CI_Firm),
industry (CI_Ind), and credit rating (CI_CR) levels, respectively, measured at the end of the nth quarter prior, with n ranging from one to eight. We then obtain pre-fee
monthly returns of these portfolios and calculate their unconditional monthly four-factor alphas. The table reports the differences in unconditional four-factor pre-fee
alphas between the most concentrated and diversified quintiles and the associated Newey-West t-statistics (in parentheses). ∗∗∗ , ∗∗ , and ∗ indicate the significance levels at
1%, 5%, and 10%, respectively.

1 2 3 4 5 6 7 8

Panel A. All Funds

CI_Firm 0.08∗ ∗ ∗ 0.08∗ ∗ ∗ 0.05∗ ∗ 0.05∗ ∗ ∗ 0.03∗ ∗ 0.00 0.01 0.02
(3.30) (2.70) (2.60) (3.39) (2.05) (0.26) (0.88) (1.20)
CI_Ind 0.07∗ ∗ ∗ 0.06∗ ∗ ∗ 0.03∗ 0.06∗ ∗ 0.05∗ ∗ 0.03 0.03 0.01
(2.64) (3.23) (1.89) (2.58) (2.06) (1.33) (1.23) (0.28)
CI_CR 0.06∗ ∗ ∗ 0.04∗ 0.05∗ ∗ 0.05∗ ∗ 0.04 0.02 0.06∗ 0.03
(2.80) (1.74) (2.07) (2.16) (1.42) (1.10) (1.74) (1.34)
Panel B. Investment-Grade Funds
CI_Firm 0.13∗ ∗ 0.13∗ 0.09∗ 0.05∗ ∗ 0.03 0.03 0.05∗ ∗ 0.07∗ ∗
(2.38) (1.85) (1.74) (2.09) (1.19) (1.59) (2.03) (2.56)
CI_Ind 0.13∗ ∗ 0.12∗ ∗ 0.07∗ 0.08 0.06∗ 0.04 0.05 0.04
(2.55) (2.34) (1.81) (1.65) (1.89) (1.28) (1.40) (1.38)
CI_CR 0.12∗ ∗ 0.08 0.07 0.05 0.06 0.11∗ 0.05 0.00
(2.23) (1.57) (1.51) (1.22) (1.13) (1.93) (1.28) (0.11)
Panel C. High-Yield Funds
CI_Firm 0.04∗ 0.04∗ 0.01 0.03 0.02 0.00 -0.01 -0.02
(1.80) (1.67) (0.68) (1.39) (1.23) (0.18) (-0.44) (-0.86)
CI_Ind 0.03 0.04∗ 0.00 0.01 0.01 0.02 -0.01 -0.02
(1.32) (1.74) (0.03) (0.46) (0.67) (0.77) (-0.62) (-0.77)
CI_CR 0.03 0.03 0.04 0.02 0.02 0.01 0.03 0.01
(1.25) (1.17) (1.60) (1.29) (1.10) (0.63) (1.15) (0.51)

3.2. The impact of liquidity
The empirical evidence thus far suggests that concentrated
corporate bond funds in general significantly outperform their
diversified counterparts. Although concentrated portfolios might
provide opportunities for managers to exploit information ad-
vantages, they could also incur significant liquidity costs. As
informed managers are likely to concentrate on a similar set of
securities, they are likely to exert significant downward price pres-
sure when they are forced to liquidate their underlying positions
to meet daily investor redemptions under unfavorable market
conditions, thus leading to significantly worse fund performance.
Such liquidation is more costly if funds hold corporate bonds with
higher sensitivities to market-wide liquidity shocks (i.e., higher

10
N. Qin and Y. Wang
liquidity betas), or during periods of market illiquidity shocks
when drops in fund performance are more likely to occur. There-
fore, we expect the documented positive relation between portfolio
concentration and corporate bond fund performance to be weaker
among funds with higher liquidity betas and during periods of
market illiquidity shocks. Furthermore, we expect the positive
concentration-performance relation to hold during periods of
inflows rather than outflows, as liquidity is more likely to be a
concern when a fund needs to sell than when it needs to buy.
3.2.1. Fund-level liquidity betas
To examine the effect of fund-level liquidity betas on the rela-
tion between portfolio concentration and corporate bond fund per-
formance, we run the following regression:
ARi,t = α + β1C Ii,t−1 ∗ LiqBet ai,t−1 + β3 LiqBet ai,t−1 + γ Xi,t−1 + εi,t ,
(11)
where LiqBeta is the fund-level liquidity beta estimated from
Eq. (9) using fund returns over the previous 36 months, and
the dependent and other independent variables are defined as in
Eq. (10). We also control for benchmark-by-time fixed effects and
use standard errors clustered by fund and time. The coefficient β2
on the interaction between concentration index and liquidity beta
(CI ∗ LiqBeta ) indicates whether fund-level liquidity betas signifi-
cantly affect the concentration-performance relation.
The results in Table 6 show that the positive concentration-
performance relation is less pronounced for funds with higher liq-
uidity betas, especially among HY funds. Based on the Amihud
measure in Panel A, for example, we find that for HY funds, β2
is significantly negative at the level of 10%, 5%, and 5% with t-
statistics of -1.76, -2.19, and -2.98 for concentration indices at
the firm, industry, and credit rating levels, respectively. The re-
sults based on the IRC measure in Panel B are qualitatively similar.
Again, we document that β2 is significantly negative at 5% level for
industry and credit rating concentration indices. Interestingly, the
coefficients (β1 ) on the three concentration indices generally be-
come significantly positive even for HY funds, suggesting that the
lack of positive concentration-performance relation for HY funds
as previously documented in Section 3.1 could be attributed to liq-
uidity. In particular, more concentrated HY funds with higher sen-
sitivities to aggregate market liquidity shocks are more likely to
incur higher liquidity costs when they are forced to liquidate their
positions to meet daily investor redemptions, thus nullifying the
potential information benefits of concentrated portfolios.
3.2.2. Market illiquidity shocks
To examine the relation between portfolio concentration and
future corporate bond fund performance conditional on aggregate
market illiquidity shocks, we estimate the following regression:
ARi,t = α + β1C Ii,t−1 + β2C Ii,t−1 ∗ NegInnot−1 + γ Xi,t−1 + εi,t , (12)
where NegInno is a dummy variable which takes the value of one
for those months with negative innovations in aggregate corporate
bond market liquidity (i.e., L in Eq. (9)), and zero otherwise, and
the dependent and other independent variables are again defined
as in Eq. (10). We also control for benchmark-by-time fixed effects
and use standard errors clustered by fund and time.16 The coef-
ficient (β2 ) on the interaction between concentration index and
market illiquidity shock dummy (CI × NegInno) indicates whether
the relation between portfolio concentration and fund performance
is significantly different across positive and negative market liquid-
ity shock regimes.
11
Journal of Banking and Finance 123 (2021) 106033
Table 7 documents similar results based on the Amihud and
IRC measures in Panels A and B, respectively. In general, we ob-
serve negative coefficients (β2 ) on CI × NegInno, indicating that the
positive relation between portfolio concentration and fund perfor-
mance is weaker during periods of market illiquidity shocks. This
result is particularly strong for HY funds, where β2 is shown to be
significantly negative regardless of the concentration indices con-
sidered. It is also worth noting that the coefficients (β1 ) on CI are
significantly positive even for HY funds, indicating that HY funds
exhibit a significant positive concentration-performance relation
when the bond market experiences positive liquidity shocks. The
results further support our conjecture that the lack of a positive
concentration-performance relation in HY funds as documented in
Section 3.1 could be attributed to liquidity: more concentrated HY
funds tend to incur higher liquidity costs during periods of market
illiquidity shocks when bad fund performance might lead to mas-
sive investor redemptions and force managers to liquidate their po-
sitions, thus at least partially offsetting the information benefits of
concentrated portfolios.
3.2.3. Fund-level inflows vs. outflows
The erosion of the value of portfolio concentration by liquidity
costs, if truly existent, should be most pronounced when a fund
experiences net money outflows, as liquidity is more likely to be
of concern when a fund needs to sell than when it needs to buy.
Therefore, we expect the positive relation between portfolio con-
centration and fund performance to be weaker during periods of
outflows. To examine this issue, we split the sample into subperi-
ods of inflows and outflows based on fund-level net flows in the
prior month and repeat the regression analysis in Eq. (10) using
the two subsamples separately.
The results in Table 8 are largely consistent with our prediction.
For instance, during periods of fund-level net inflows (Panel A), we
show that portfolio concentration is significantly positively related
to future fund performance mostly at the 1% level for all funds
as well as IG and HY funds. During periods of fund-level net out-
flows (Panel B), however, we find that the positive concentration-
performance relation only exists for IG funds when concentration
index is measured at the industry level. Therefore, portfolio con-
centration appears to add value to HY funds when they experience
net money inflows, while its value seems to be completely eroded
by the associated liquidity costs when the funds experience net
money outflows.
3.2.4. Further evidence
The empirical evidence thus far suggests that the lack of pre-
dictability of portfolio concentration for HY fund performance
could be attributed to the higher liquidity costs of more concen-
trated portfolios. For instance, consider two HY funds that hold
bonds with high sensitivities to market illiquidity innovations: one
has bonds in all industries (less concentrated) and the other has
bonds in only one industry (more concentrated). If they are forced
to liquidate their positions to meet investor redemptions in unfa-
vorable market conditions (e.g., during periods of market illiquidity
shocks), the more concentrated fund could suffer greater liquidity
costs because it is likely to cause significantly more price pressure
due to its relatively larger positions in the underlying bonds.
To provide further evidence for the above conjecture, we run
regressions of the number of sells and average sell size (in both
absolute and relative terms) across all sells of corporate bond
funds, respectively, on portfolio concentration, controlling for
various fund characteristics and benchmark-by-time fixed effects.
16
NegInno is omitted from the regression due to its multicollinearity with
benchmark-by-month fixed effects.
N. Qin and Y. Wang Journal of Banking and Finance 123 (2021) 106033

Table 6
The Impact of Fund-Level Liquidity Beta. The table shows the impact of fund-level liquidity beta on the relation between portfolio concentration and corporate bond fund
performance during July 2002-December 2017. Columns 1-3, 4-6, and 7-9 show the results based on all, investment-grade (IG), and high-yield (HY) corporate bond funds,
respectively. The dependent variable is the monthly fitted pre-fee abnormal returns estimated as the differences between realized pre-fee returns and returns predicted
by fund factor loadings and the realizations of the factors, where factor loadings are estimated based on the unconditional four-factor model using pre-fee returns over
the previous 36 months. Concentration Index (CI) is measured at the end of the previous quarter at the firm (CI_Firm), industry (CI_Ind), and credit rating (CI_CR) levels,
respectively, and demeaned within the IG or HY fund category. Fund-level liquidity beta (LIQBETA) is estimated by regressing monthly fund returns on the four factors
and a bond market liquidity factor (L) over the previous 36 months. Panels A and B report the results when L is estimated based on the Amihud and imputed roundtrip
cost (IRC) measures, respectively. Other controlled fund characteristics include lagged expense ratio (EXP), turnover rate (TO), the natural logarithm of fund age (Ln[Age]),
total net assets (Ln[TNA]), and fund family size (Ln[FS]), and net flow ratio (Flow). We control for benchmark-by-time (B × T) fixed effects in all regressions and report
t-statistics (in parentheses) based on standard errors clustered by fund and time. ∗∗∗ , ∗∗ , and ∗ indicate the significance levels at 1%, 5%, and 10%, respectively.

All Funds Investment-Grade Funds High-Yield Funds

[1] [2] [3] [4] [5] [6] [7] [8] [9]

CI_Firm CI_Ind CI_CR CI_Firm CI_Ind CI_CR CI_Firm CI_Ind CI_CR

Panel A. Amihud Measure

Intercept 0.03 0.03 0.08∗ -0.16∗ ∗ -0.04 -0.03 -0.20 -0.06 -0.07
(0.85) (0.64) (1.91) (-2.14) (-0.93) (-0.64) (-1.15) (-0.60) (-0.66)
CI 0.22∗ ∗ ∗ 0.19∗ ∗ 0.27∗ ∗ ∗ 0.18∗ ∗ 0.07 0.22∗ ∗ ∗ 0.38∗ 0.45∗ ∗ 0.72∗ ∗
(2.68) (1.98) (3.82) (2.21) (0.80) (3.35) (1.90) (1.98) (2.55)
CI∗ LIQBETA -0.09 -0.08 -0.28∗ ∗ ∗ 0.01 0.22 -0.27∗ -0.33∗ -0.46∗ ∗ -0.71∗ ∗ ∗
(-1.01) (-0.83) (-2.70) (0.10) (1.06) (-1.70) (-1.76) (-2.19) (-2.98)
LIQBETA 0.00 0.00 0.00 -0.01 -0.06 0.09 0.21 0.11∗ 0.12∗ ∗
(0.11) (0.19) (0.02) (-0.10) (-0.88) (1.33) (1.55) (1.70) (2.05)
EXP 2.03 2.33 1.71 1.18 1.86 1.02 4.60 4.56 4.58
(1.07) (1.30) (0.96) (0.71) (0.96) (0.52) (1.05) (1.00) (1.04)
TO 0.02∗ ∗ ∗ 0.02∗ ∗ ∗ 0.02∗ ∗ 0.01∗ 0.01 0.01 0.03∗ ∗ 0.03∗ ∗ 0.03∗ ∗
(3.09) (2.63) (2.31) (1.90) (1.46) (1.38) (2.34) (2.32) (2.19)
Ln[Age] -0.01 -0.01 -0.01 0.00 0.00 0.00 -0.01 -0.01 -0.01
(-1.28) (-0.91) (-0.79) (0.47) (0.51) (0.29) (-1.03) (-0.91) (-0.65)
Ln[TNA] 0.00 0.00 -0.00 0.00 0.00 -0.00 0.00 0.00 0.00
(0.54) (0.59) (-0.19) (0.76) (0.82) (-0.06) (0.48) (0.50) (0.38)
Ln[FS] 0.01∗ ∗ 0.01∗ ∗ 0.00 0.00 0.00 -0.00 0.01 0.01 0.01
(2.42) (2.09) (0.97) (1.04) (0.61) (-0.19) (1.34) (1.37) (1.19)
Flow -0.00 -0.02 0.03 0.13 0.13 0.14 -0.03 -0.14 -0.05
(-0.01) (-0.12) (0.16) (1.20) (0.86) (1.12) (-0.11) (-0.51) (-0.17)
B × T Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
2
R 0.750 0.750 0.750 0.420 0.380 0.340 0.830 0.830 0.830
N 34,477 34,463 34,449 17,877 17,823 17,784 16,525 16,441 16,516
Panel B. IRC Measure
Intercept 0.04 0.03 0.09∗ ∗ -0.16∗ ∗ -0.07 -0.03 -0.15 -0.03 -0.02
(1.05) (0.86) (2.22) (-2.14) (-1.37) (-0.58) (-0.91) (-0.30) (-0.17)
CI 0.22∗ ∗ ∗ 0.22∗ ∗ ∗ 0.25∗ ∗ ∗ 0.17∗ ∗ 0.16∗ ∗ 0.20∗ ∗ ∗ 0.35∗ 0.43∗ ∗ 0.60∗ ∗
(2.98) (2.64) (3.55) (2.31) (2.16) (3.16) (1.85) (2.18) (2.40)
CI∗ LIQBETA -0.92 -1.61 -3.43∗ ∗ ∗ 0.73 -0.85 -2.45 -3.76 -5.81∗ ∗ -8.76∗ ∗ ∗
(-0.91) (-1.63) (-2.65) (0.41) (-0.42) (-1.43) (-1.54) (-2.13) (-2.65)
LIQBETA -0.20 -0.26 -0.22 -0.65 0.06 0.69 2.01 0.98 1.16
(-0.66) (-0.84) (-0.70) (-0.43) (0.07) (0.88) (1.15) (1.25) (1.60)
EXP 2.34 2.74 1.91 1.26 1.70 1.12 5.05 4.83 4.92
(1.23) (1.52) (1.09) (0.77) (0.86) (0.58) (1.20) (1.15) (1.22)
TO 0.02∗ ∗ ∗ 0.02∗ ∗ ∗ 0.02∗ ∗ 0.01∗ 0.01 0.01 0.03∗ ∗ 0.03∗ ∗ 0.03∗ ∗
(3.12) (2.62) (2.26) (1.91) (1.49) (1.33) (2.41) (2.24) (2.04)
Ln[Age] -0.01 -0.01 -0.00 0.00 0.00 0.00 -0.01 -0.01 -0.01
(-1.27) (-0.89) (-0.71) (0.52) (0.51) (0.39) (-1.13) (-0.94) (-0.86)
Ln[TNA] 0.00 0.00 -0.00 0.00 0.00 0.00 0.00 0.00 0.00
(0.66) (0.75) (-0.03) (0.79) (0.89) (0.09) (0.47) (0.39) (0.30)
Ln[FS] 0.01∗ ∗ 0.01∗ ∗ 0.00 0.00 0.00 -0.00 0.01 0.01 0.01
(2.37) (2.05) (0.88) (1.03) (0.57) (-0.25) (1.34) (1.42) (1.12)
Flow -0.00 -0.02 0.03 0.13 0.13 0.15 -0.02 -0.13 -0.04
(-0.01) (-0.12) (0.18) (1.21) (0.82) (1.21) (-0.07) (-0.46) (-0.14)
B × T Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.750 0.750 0.750 0.420 0.380 0.340 0.830 0.830 0.830
N 34,477 34,463 34,449 17,877 17,823 17,784 16,525 16,441 16,516

Specifically, the number of sells is defined as the number of hold-
ing positions with declining par value, so it is the lower bound of
the true number of sells by the fund during a given month. Sell
size is defined as the decrease in par value of a selling position.
Relative sell size is measured as sell size as a fraction of the bond’s
total par amounts outstanding. In support of our conjecture, the
untabulated evidence suggests that more concentrated HY funds
tend to have fewer but larger (in both absolute and relative terms)
sells compared to their diversified counterparts. Therefore, as more
concentrated HY funds are forced to unload these larger positions,
they are likely to induce greater price impact and thus subject to
greater liquidity costs.
3.3. Portfolio concentration and performance persistence
While equity funds show little evidence of performance persis-
tence (Carhart, 1997; Berk and Green, 2004), bond funds have been
shown to exhibit significant persistence in performance (Huij and
Derwall, 2008). If portfolio concentration indicates managerial
skills, it is natural to ask whether more concentrated funds exhibit
stronger performance persistence. To answer this question, we es-
timate the following regression:
ARi,t = α + β1C Ii,t−1 + β2C Ii,t−1 × PastPer fi,t−1 + δ Xi,t−1 + εi,t ,
(13)

12
N. Qin and Y. Wang Journal of Banking and Finance 123 (2021) 106033

Table 7
The Impact of Bond Market Illiquidity Shocks. The table shows the impact of bond market illiquidity shocks on the relation between portfolio concentration and corporate
bond fund performance during July 2002-December 2017. Columns 1-3, 4-6, and 7-9 show the results based on all, investment-grade (IG), and high-yield (HY) corporate
bond funds, respectively. The dependent variable is the monthly fitted pre-fee abnormal returns estimated as the differences between realized pre-fee returns and returns
predicted by fund factor loadings and the realizations of the factors, where factor loadings are estimated based on the unconditional four-factor model using pre-fee returns
over the previous 36 months. Concentration Index (CI) is measured at the end of the previous quarter at the firm (CI_Firm), industry (CI_Ind), and credit rating (CI_CR)
levels, respectively, and demeaned within the IG or HY fund category. NegInno is a dummy variable indicating negative innovations in aggregate bond market liquidity.
Panels A and B report the results when bond market illiquidity is estimated from the Amihud and imputed roundtrip cost (IRC) measures, respectively. Other controlled
fund characteristics include lagged expense ratio (EXP), turnover rate (TO), the natural logarithm of fund age (Ln[Age]), total net assets (Ln[TNA]), and fund family size
(Ln[FS]), and net flow ratio (Flow). We control for benchmark-by-time (B × T) fixed effects in all regressions and report t-statistics (in parentheses) based on standard
errors clustered by fund and time. ∗∗∗ , ∗∗ , and ∗ indicate the significance levels at 1%, 5%, and 10%, respectively.

All Funds Investment-Grade Funds High-Yield Funds

[1] [2] [3] [4] [5] [6] [7] [8] [9]

CI_Firm CI_Ind CI_CR CI_Firm CI_Ind CI_CR CI_Firm CI_Ind CI_CR

Panel A. Amihud Measure

Intercept 0.04 0.03 0.08∗ ∗ -0.16∗ ∗ -0.05 -0.00 -0.00 0.03 0.04
(1.13) (0.89) (2.13) (-2.18) (-1.13) (-0.01) (-0.00) (0.32) (0.52)
CI 0.31∗ ∗ ∗ 0.27∗ ∗ ∗ 0.29∗ ∗ ∗ 0.25∗ ∗ ∗ 0.19∗ ∗ 0.16∗ ∗ 0.30∗ ∗ 0.36∗ ∗ 0.64∗ ∗ ∗
(3.67) (2.75) (2.86) (2.88) (2.21) (2.47) (2.17) (2.17) (2.86)
CI∗ NegInno -0.21∗ ∗ -0.17 -0.23∗ -0.12 -0.07 -0.02 -0.40∗ ∗ -0.55∗ -1.09∗ ∗ ∗
(-1.98) (-1.29) (-1.84) (-1.22) (-0.70) (-0.21) (-2.19) (-1.86) (-2.91)
EXP 1.77 2.20 1.11 0.95 1.31 0.56 2.68 3.48 2.61
(0.87) (1.13) (0.55) (0.57) (0.70) (0.29) (0.64) (0.80) (0.58)
TO 0.02∗ ∗ ∗ 0.02∗ ∗ ∗ 0.02∗ ∗ ∗ 0.01∗ 0.01∗ ∗ 0.01 0.03∗ ∗ ∗ 0.04∗ ∗ ∗ 0.03∗ ∗ ∗
(3.15) (3.33) (2.73) (1.73) (1.99) (1.42) (3.02) (3.69) (3.54)
Ln[Age] -0.00 -0.00 -0.00 0.00 0.00 0.00 -0.00 -0.01 -0.00
(-0.65) (-0.57) (-0.01) (0.38) (0.33) (0.44) (-0.41) (-0.63) (-0.06)
Ln[TNA] 0.00 0.00 0.00 0.00 0.00 -0.00 0.01 0.01 0.01
(0.97) (1.07) (0.10) (0.60) (0.75) (-0.30) (0.98) (0.98) (0.87)
Ln[FS] 0.01∗ 0.00∗ 0.00 0.00 0.00 -0.00 0.01 0.01 0.01
(1.95) (1.71) (0.69) (1.23) (0.78) (-0.10) (0.89) (1.13) (0.90)
Flow -0.03 -0.05 -0.00 0.14 0.13 0.14 -0.09 -0.16 -0.06
(-0.21) (-0.28) (-0.02) (1.35) (0.96) (1.22) (-0.35) (-0.67) (-0.26)
B × T Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.740 0.740 0.740 0.410 0.370 0.330 0.820 0.810 0.810
N 38,926 38,926 38,888 20,287 20,227 20,157 18,568 18,470 18,547
Panel B. IRC Measure
Intercept 0.04 0.03 0.08∗ ∗ -0.16∗ ∗ -0.05 -0.00 0.00 0.02 0.04
(1.13) (0.89) (2.15) (-2.17) (-1.13) (-0.00) (0.01) (0.27) (0.45)
CI 0.28∗ ∗ ∗ 0.28∗ ∗ ∗ 0.29∗ ∗ ∗ 0.22∗ ∗ ∗ 0.15∗ ∗ 0.17∗ ∗ ∗ 0.26∗ 0.40∗ ∗ 0.64∗ ∗ ∗
(3.40) (3.23) (3.12) (2.80) (2.06) (2.64) (1.95) (2.43) (2.90)
CI∗ NegInno -0.17∗ -0.21∗ -0.28∗ ∗ -0.06 0.02 -0.03 -0.37∗ ∗ -0.71∗ ∗ -1.23∗ ∗ ∗
(-1.69) (-1.71) (-2.32) (-0.66) (0.21) (-0.39) (-2.14) (-2.36) (-3.09)
EXP 1.76 2.19 1.10 0.95 1.32 0.56 2.66 3.45 2.75
(0.86) (1.12) (0.55) (0.58) (0.70) (0.29) (0.64) (0.79) (0.61)
TO 0.02∗ ∗ ∗ 0.02∗ ∗ ∗ 0.02∗ ∗ ∗ 0.01∗ 0.01∗ ∗ 0.01 0.03∗ ∗ ∗ 0.04∗ ∗ ∗ 0.03∗ ∗ ∗
(3.13) (3.30) (2.68) (1.72) (1.99) (1.42) (3.04) (3.73) (3.49)
Ln[Age] -0.00 -0.00 -0.00 0.00 0.00 0.00 -0.00 -0.01 -0.00
(-0.63) (-0.55) (-0.01) (0.39) (0.32) (0.44) (-0.40) (-0.62) (-0.09)
Ln[TNA] 0.00 0.00 0.00 0.00 0.00 -0.00 0.01 0.01 0.01
(0.96) (1.07) (0.11) (0.60) (0.75) (-0.30) (0.96) (1.00) (0.90)
Ln[FS] 0.00∗ 0.00∗ 0.00 0.00 0.00 -0.00 0.01 0.01 0.01
(1.94) (1.71) (0.68) (1.23) (0.77) (-0.11) (0.90) (1.15) (0.92)
Flow -0.03 -0.04 -0.00 0.14 0.13 0.14 -0.10 -0.17 -0.07
(-0.22) (-0.28) (-0.02) (1.37) (0.96) (1.22) (-0.37) (-0.69) (-0.28)
B × T Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.740 0.740 0.740 0.410 0.370 0.330 0.820 0.820 0.810
N 38,926 38,926 38,888 20,287 20,227 20,157 18,568 18,470 18,547

where PastPerf is past fund performance measured as the decile
ranking (within the IG or HY fund category) of a fund’s average
monthly alpha over the prior three months, and the dependent and
other independent variables are again defined as in Eq. (10). We
also control for benchmark-by-time fixed effects and use standard
errors clustered by fund and time. A significant positive coefficient
(β2 ) on the interaction between concentration index and past fund
performance (CI × PastPer f ) indicates stronger performance persis-
tence among more concentrated funds.
Table 9 reports results regarding the effect of portfolio concen-
tration on performance persistence in corporate bond funds. First,
consistent with the literature (e.g., Huij and Derwall, 2008), Col-
umn 1 shows that corporate bond funds exhibit significant per-
sistence in performance. More interestingly, Columns 2-4 show
that the coefficients (β2 ) on CI × PastPer f are positive and signif-
icant at the 5% level for firm-level and industry concentration in-
dices. Overall, the evidence shows that more concentrated corpo-
rate bond funds exhibit stronger performance persistence, suggest-
ing that portfolio concentration is indicative of superior managerial
skills.
3.4. Portfolio concentration and the flow-performance relation
If portfolio concentration indicates managerial skills, then an-
other natural question is whether investors are aware of the posi-
tive relation between concentration and corporate bond fund per-
formance and allocate their money accordingly. To examine sthis
issue, we estimate the following panel regression:
F lowi,t = α + β1C Ii,t−1 + β2C Ii,t−1 × PastPer fi,t−1
+β3 PastPer fi,t−1 + δ Xi,t−1 + εi,t , (14)

13
N. Qin and Y. Wang Journal of Banking and Finance 123 (2021) 106033

Table 8
Subperiod Regression Analysis: Fund-level Inflows versus Outflows. The table reports subperiod regression results of corporate bond fund performance on portfolio con-
centration, controlling for various fund characteristics, during July 2002-December 2017. Panels A and B present results during subperiods of funds experiencing net money
inflows and outflows in the prior month, respectively. Columns 1-3, 4-6, and 7-9 show results based on all, investment-grade (IG), and high-yield (HY) corporate bond
funds, respectively. The dependent variable is the monthly fitted pre-fee abnormal returns estimated as the differences between realized pre-fee returns and returns pre-
dicted by fund factor loadings and the realizations of the factors, where factor loadings are estimated based on the unconditional four-factor model using pre-fee returns
over the previous 36 months. Concentration Index (CI) is measured at the end of the previous quarter at the firm (CI_Firm), industry (CI_Ind), and credit rating (CI_CR)
levels, respectively, and demeaned within the IG or HY fund category. Other controlled fund characteristics include lagged expense ratio (EXP), turnover rate (TO), the
natural logarithm of fund age (Ln[Age]), total net assets (Ln[TNA]), and fund family size (Ln[FS]), and net flow ratio (Flow). We control for benchmark-by-time (B × T) fixed
effects in all regressions and report t-statistics (in parentheses) based on standard errors clustered by fund and time. ∗∗∗ , ∗∗ , and ∗ indicate the significance levels at 1%, 5%,
and 10%, respectively.

All Funds Investment-Grade Funds High-Yield Funds

[1] [2] [3] [4] [5] [6] [7] [8] [9]

CI_Firm CI_Ind CI_CR CI_Firm CI_Ind CI_CR CI_Firm CI_Ind CI_CR

Panel A. Fund-level Inflows

Intercept -0.01 0.01 0.06 -0.31∗ ∗ ∗ -0.07 -0.07 -0.11 -0.03 0.00
(-0.20) (0.32) (1.43) (-3.23) (-1.28) (-1.42) (-0.82) (-0.29) (0.02)
CI 0.39∗ ∗ ∗ 0.34∗ ∗ ∗ 0.34∗ ∗ ∗ 0.31∗ ∗ ∗ 0.15∗ 0.20∗ ∗ ∗ 0.38∗ ∗ ∗ 0.49∗ ∗ ∗ 0.67∗ ∗ ∗
(4.82) (3.57) (4.18) (3.54) (1.79) (3.05) (3.07) (2.85) (3.40)
EXP 4.28 4.58∗ 4.50∗ 2.34 2.44 3.01 2.69 4.79 4.40
(1.52) (1.71) (1.67) (0.94) (0.99) (1.19) (0.52) (0.97) (0.90)
TO -0.01 -0.00 -0.00 0.01 0.01 0.00 -0.01∗ ∗ ∗ -0.01∗ ∗ -0.00∗ ∗
(-1.24) (-0.62) (-1.25) (1.00) (0.65) (0.04) (-3.57) (-2.26) (-2.00)
Ln[Age] 0.00 0.00 0.00 0.01 0.01 0.01 0.00 0.00 0.01
(0.07) (0.08) (0.31) (0.64) (1.06) (1.08) (0.17) (0.04) (0.39)
Ln[TNA] 0.00 0.01 0.00 0.00 -0.00 -0.00 0.01 0.01 0.01
(0.95) (1.12) (0.10) (0.05) (-0.02) (-0.75) (1.25) (1.32) (1.01)
Ln[FS] 0.01∗ ∗ ∗ 0.01∗ ∗ 0.01 0.01∗ ∗ ∗ 0.01 0.01 0.00 0.00 0.00
(2.95) (2.13) (1.37) (2.80) (1.43) (1.40) (0.03) (0.49) (0.16)
Flow 0.01 -0.06 -0.03 0.19 0.06 0.13 -0.15 -0.17 -0.10
(0.06) (-0.31) (-0.16) (1.18) (0.40) (0.89) (-0.54) (-0.55) (-0.32)
B × T Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.730 0.730 0.730 0.380 0.350 0.300 0.800 0.790 0.790
N 18,710 18,618 18,687 9,878 9,785 9,880 8,642 8,572 8,611
Panel B. Fund-level Outflows
Intercept 0.05 0.03 0.07 -0.07 -0.05 0.07 0.07 0.06 0.06
(0.80) (0.52) (0.90) (-0.74) (-0.91) (1.16) (0.51) (0.48) (0.42)
CI -0.00 -0.01 -0.04 0.13 0.20∗ ∗ 0.10 -0.12 -0.25 -0.38
(-0.04) (-0.04) (-0.32) (1.34) (2.53) (1.36) (-0.85) (-1.08) (-1.01)
EXP 1.97 1.51 0.67 -0.24 0.42 -0.58 2.46 2.72 3.36
(0.60) (0.43) (0.18) (-0.10) (0.18) (-0.22) (0.45) (0.43) (0.53)
TO 0.01∗ ∗ 0.01∗ 0.01∗ ∗ 0.01 0.02∗ 0.01∗ 0.02 0.02 0.02
(1.98) (1.85) (2.02) (1.39) (1.92) (1.66) (1.47) (1.36) (1.33)
Ln[Age] -0.01 -0.00 -0.01 -0.00 -0.01 -0.01 0.00 -0.00 -0.01
(-0.72) (-0.50) (-0.67) (-0.34) (-0.55) (-0.52) (0.18) (-0.16) (-0.44)
Ln[TNA] -0.00 -0.00 -0.00 0.00 0.01 0.00 -0.01 -0.01 -0.01
(-0.60) (-0.21) (-0.12) (0.79) (0.82) (0.16) (-1.36) (-1.10) (-0.83)
Ln[FS] 0.01 0.01 0.00 -0.00 0.00 -0.01 0.02∗ 0.02 0.02
(1.19) (1.09) (0.54) (-0.60) (0.04) (-1.55) (1.91) (1.45) (1.55)
Flow -0.15 -0.08 -0.06 -0.13 0.12 -0.05 -0.02 -0.11 -0.04
(-0.74) (-0.38) (-0.28) (-0.78) (0.53) (-0.23) (-0.06) (-0.37) (-0.13)
B × T Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0.750 0.750 0.740 0.470 0.410 0.370 0.810 0.810 0.800
N 19,996 19,967 20,009 10,000 9,934 10,021 9,819 9,769 9,808

where F low is the monthly net fund flow ratio, and all the
other variables are defined as in Eq. (13).17 Again we control for
benchmark-by-time fixed effects and use standard errors clustered
by fund and time. If the coefficient (β2 ) on the interaction between
concentration index and past fund performance (CI × PastPer f ) is
significantly positive, we argue that corporate bond fund investors
take into account portfolio concentration in making their invest-
ment decisions.
Table 10 reports regression results. As shown in Column 1, there
exists a significant positive relation between fund flows and past
fund performance, suggesting that investors respond positively to
past fund performance. From Columns 2-4, β2 is significantly pos-
itive at the 1% level for all three portfolio concentration indices,
17
As a robustness check, we also measure past fund performance as the decile
ranking (within the IG or HY fund category) of a fund’s average monthly alpha over
the prior 12 months to account for possibly stronger performance persistence in
more concentrated funds. The untabulated results remain qualitatively similar.
indicating that the higher the degree of portfolio concentration,
the more sensitive fund flows to past fund performance. Overall,
the results suggest that investors assign a greater weight to past
fund performance in their decision-making process for more con-
centrated funds. This is probably because investors consider better
past performance, in conjunction with greater portfolio concentra-
tion, as a more accurate signal of managerial skills.
3.5. Robustness tests
We provide several robustness tests. First, we use conditional
models to control for the responses of corporate bond funds to
various macroeconomic conditions in evaluating fund performance.
Second, to mitigate the concern that our results are merely driven
by the holdings of non-corporate bonds or by return smoothing of
corporate bond funds (Cici et al., 2011), we use returns to corpo-
rate bond holdings instead of the reported fund returns. Third, we
further control for liquidity risk in evaluating fund performance.

14
N. Qin and Y. Wang Journal of Banking and Finance 123 (2021) 106033

Table 9
Portfolio Concentration and Performance Persistence. The table shows the impact of portfolio concentration on performance persistence of U.S. corporate bond mutual
funds during July 2002-December 2017. The dependent variable is the monthly fitted pre-fee abnormal returns estimated as the differences between realized pre-fee
returns and returns predicted by fund factor loadings and the realizations of the factors, where factor loadings are estimated based on the unconditional four-factor model
using pre-fee returns over the previous 36 months. Concentration Index (CI) is measured at the end of the previous quarter at the firm (CI_Firm), industry (CI_Ind), and
credit rating (CI_CR) levels, respectively, and demeaned within the investment-grade (IG) or high-yield (HY) fund category. Past fund performance (PastPerf) is measured
as the decile ranking of average fund alpha over the prior three months within the IG or HY fund category. Other controlled fund characteristics include lagged expense
ratio (EXP), turnover rate (TO), the natural logarithm of fund age (Ln[Age]), total net assets (Ln[TNA]), and fund family size (Ln[FS]), and net flow ratio (Flow). We control
for benchmark-by-time (B × T) fixed effects in all regressions and report t-statistics (in parentheses) based on standard errors clustered by fund and time. ∗∗∗ , ∗∗ , and ∗
indicate the significance levels at 1%, 5%, and 10%, respectively.

Concentration Index

CI_Firm CI_Ind CI_CR

[1] [2] [3] [4]

Intercept -0.07 -0.02 -0.03 0.02

(-1.20) (-0.63) (-0.80) (0.46)
CI -0.00 -0.03 0.03
(-0.01) (-0.27) (0.24)
CI∗ PastPerf 0.04∗ ∗ 0.04∗ ∗ ∗ 0.03
(2.23) (2.61) (1.53)
PastPerf 0.02∗ ∗ ∗ 0.02∗ ∗ ∗ 0.02∗ ∗ ∗ 0.02∗ ∗ ∗
(4.95) (5.15) (5.31) (5.15)
EXP 0.03 0.01 0.02 0.01
(1.30) (0.68) (0.94) (0.29)
TO 0.02∗ ∗ ∗ 0.01∗ ∗ 0.01∗ ∗ ∗ 0.01∗ ∗
(2.61) (2.58) (2.79) (2.39)
Ln[Age] -0.00 -0.00 -0.00 -0.00
(-0.76) (-0.86) (-0.82) (-0.33)
Ln[TNA] -0.00 0.00 0.00 -0.00
(-0.34) (0.51) (0.69) (-0.27)
Ln[FS] 0.00 0.00∗ ∗ 0.00∗ 0.00
(0.90) (2.05) (1.86) (0.88)
Flow -0.20 -0.15 -0.15 -0.10
(-0.75) (-0.94) (-0.98) (-0.64)
B × T Fixed Effects Yes Yes Yes Yes
R2 0.480 0.740 0.740 0.740
N 38,685 38,593 38,589 38,555

Table 10
Portfolio Concentration and the Flow-performance Relation. The table shows the impact of portfolio concentration on the sensitivity of fund flows to past performance of
U.S. corporate bond mutual funds during July 2002-December 2017. The dependent variable is the monthly net money flow ratio. Concentration Index (CI) is measured
at the end of the previous quarter at the firm (CI_Firm), industry (CI_Ind), and credit rating (CI_CR) levels, respectively, and demeaned within the investment-grade (IG)
or high-yield (HY) fund category. Past fund performance (PastPerf) is measured as the decile ranking of average fund alpha over the prior three months within the IG or
HY fund category. Other controlled fund characteristics include lagged expense ratio (EXP), turnover rate (TO), the natural logarithm of fund age (Ln[Age]), total net assets
(Ln[TNA]), and fund family size (Ln[FS]), and net flow ratio (Flow). We control for benchmark-by-time (B × T) fixed effects in all regressions and report t-statistics (in
parentheses) based on standard errors clustered by fund and time. ∗∗∗ , ∗∗ , and ∗ indicate the significance levels at 1%, 5%, and 10%, respectively.

CI_Firm CI_Ind CI_CR

[1] [2] [3] [4]

Intercept 0.47∗ ∗ 0.35 0.36 0.50∗ ∗

(2.06) (1.52) (1.50) (2.20)
CI -1.59∗ ∗ ∗ -1.01∗ -0.97∗
(-2.67) (-1.78) (-1.67)
CI∗ PastPerf 0.46∗ ∗ ∗ 0.35∗ ∗ ∗ 0.32∗ ∗ ∗
(4.80) (3.48) (3.10)
PastPerf 0.09∗ ∗ ∗ 0.08∗ ∗ ∗ 0.08∗ ∗ ∗ 0.08∗ ∗ ∗
(8.83) (8.58) (8.45) (8.27)
EXP -0.23∗ -0.24∗ -0.25∗ -0.28∗ ∗
(-1.87) (-1.93) (-1.97) (-2.24)
TO -0.01 -0.02 -0.00 -0.01
(-0.12) (-0.46) (-0.07) (-0.29)
Ln[Age] -0.38∗ ∗ ∗ -0.38∗ ∗ ∗ -0.37∗ ∗ ∗ -0.38∗ ∗ ∗
(-5.96) (-6.15) (-6.09) (-6.10)
Ln[TNA] 0.06∗ ∗ 0.07∗ ∗ ∗ 0.08∗ ∗ ∗ 0.07∗ ∗
(2.17) (2.61) (2.69) (2.56)
Ln[FS] 0.01 0.01 0.01 0.00
(0.30) (0.61) (0.38) (0.06)
Flow 0.29∗ ∗ ∗ 0.29∗ ∗ ∗ 0.29∗ ∗ ∗ 0.29∗ ∗ ∗
(12.28) (12.75) (12.99) (13.01)
B × T Fixed Effects Yes Yes Yes Yes
R2 0.160 0.220 0.220 0.210
N 38,865 38,775 38,775 38,741

15
N. Qin and Y. Wang
Fourth, we examine whether the concentration-performance rela-
tion is mechanically driven by factor returns. Finally, we adopt the
number of corporate bond holdings as an alternative measure of
portfolio concentration.
3.5.1. Conditional model
To ensure that our results are not driven by the different re-
sponses of concentrated and diversified corporate bond funds to
various macroeconomic conditions, we evaluate fund performance
using the conditional four-factor model in Eq. (5) as a robustness
test. The untabulated results based on the conditional model are
qualitatively similar to those based on the unconditional model.
For instance, based on the firm-level, industry, and credit rating
concentration indices, the differences in pre-fee (post-fee) condi-
tional alphas between the most and least concentrated portfolios
are 7, 6, and 6 (5, 5, and 5) bps per month, respectively, all sig-
nificant at the 1% or 5% level. Moreover, we show that the outper-
formance (as measured by the conditional alpha) of the most con-
centrated portfolios relative to their most diversified counterparts
only exists for IG funds, but not for HY funds. Overall, our results
are robust to the use of the conditional model.
3.5.2. Returns to corporate bond holdings
As shown in Table 2, an average corporate bond fund in our
sample invests 62% of its assets in corporate bonds. To ensure that
our results are not driven by the non-corporate bond holdings,
we repeat our baseline portfolio analysis using holdings-based re-
turns (i.e., value-weighted returns of all corporate bonds held by
the fund) instead of the reported fund returns. It is worth noting
that using holdings-based returns could also mitigate the concern
that our results are simply driven by return smoothing of corporate
bond funds (Cici et al., 2011), as this measure is arguably unlikely
to be subject to the same return smoothing problem as in the re-
ported returns.
The untabulated results using holdings-based returns are
qualitatively similar to those based on the reported fund returns.
For instance, the differences in holdings-based alphas between
the most concentrated and diversified portfolios are 9, 6, and 7
bps per month, respectively, for firm-level, industry, and credit
rating concentration indices. Overall, the results indicate that the
outperformance of concentrated corporate bond funds relative
to their diversified counterparts cannot be attributed to their
non-corporate bond holdings or the use of smoothed corporate
bond fund returns.
3.5.3. Controlling for liquidity risk
Lin et al. (2011) show that significant liquidity risk premium
exists in U.S. corporate bonds. It is possible that the documented
positive concentration-performance relation, especially among IG
funds, is mainly driven by the failure to control for liquidity risk
in evaluating corporate bond fund performance. To preclude this
possibility, we repeat our main analysis using the five-factor model
in Eq. (9), which further controls for a liquidity risk factor (L), in
calculating abnormal corporate bond fund returns.
The untabulated evidence shows that our main results are ro-
bust to controlling for liquidity risk in evaluating fund performance
regardless of whether L is estimated based on the Amihud or IRC
measure. For instance, the portfolio results show that for all (IG)
funds, the differences in pre-fee liquidity-risk-adjusted alphas be-
tween the most and least concentrated portfolios are 8, 7, and 6
(13, 12, and 12) bps per month when concentration is measured
at the firm, industry, and credit rating levels, respectively, all sig-
nificant at the 1% or 5% level. HY funds, however, do not exhibit
such a pattern except in the case of firm-level concentration index.
Similarly, the regression results indicate that the relation between
16
Journal of Banking and Finance 123 (2021) 106033
concentration and liquidity-risk-adjusted fund alpha is still signif-
icantly positive for all funds and IG funds, but not for HY funds.
Overall, the documented positive concentration-performance rela-
tion is not merely a consequence of failing to control for liquidity
risk in performance evaluation.
3.5.4. The effect of factor returns
It is possible that the documented positive concentration-
performance relation is mechanically driven by factor returns
rather than a result of managerial ability. To address this con-
cern, we conduct two more robustness tests following Amihud and
Goyenko (2013).
First, we obtain the coefficients on concentration index, βt ,
from Eq. (10) each month, and then run time-series regressions of
monthly estimates of βt on the four factors in Eq. (4). We exam-
ine whether the intercept is significantly positive after controlling
for the effects of the factor returns on βt . The untabulated results
show that for all funds and IG funds, the intercepts are all posi-
tive and mostly significant in five out of six cases. Overall, the ev-
idence suggests that the positive concentration-performance rela-
tion is not mechanically induced by the factor returns.
Second, in the portfolio analysis, we regress equal-weighted
monthly average four-factor pre-fee alphas (instead of excess pre-
fee returns) on the four factor returns for each quintile portfolio.
If the positive concentration-performance relation is mechanically
driven by the factor returns, the difference in the intercept (ob-
tained from this regression) between the most concentrated and
diversified quintile portfolios (5-1) should be all close to zero. The
untabulated results show that the 5-1 spreads remain significantly
positive and comparable to what we find in the baseline portfo-
lio analysis, indicating that the documented positive concentration-
performance relation is not mechanical. For instance, for all funds,
the monthly spreads are 5, 4, and 4 bps with t-statistics of 2.29,
1.68, and 2.33, when concentration is measured at the firm, indus-
try, and credit rating levels, respectively. Similarly, for IG funds, the
spread is 7 bps per month which is statistically significant at the
5% level across the three concentration indices.
3.5.5. Alternative measure of portfolio concentration
Using the number of securities held to proxy for portfolio
concentration, Sapp and Yan (2008) find that concentrated equity
funds actually underperform their diversified counterparts. To
ensure that the documented positive concentration-performance
relation is not driven by the particular concentration measures
used, we repeat our main analysis using the number of corpo-
rate bond holdings (NOH) as an alternative (inverse) measure of
concentration.
The untabulated results based on NOH are largely consistent
with our baseline results. For instance, we show that the lowest-
NOH (i.e., the most concentrated) quintile portfolio significantly
outperforms the highest-NOH (i.e., the most diversified) quintile
portfolio by 9 bps per month (t = 2.23) among all funds. Moreover,
this result only holds for IG funds but not for HY funds. Specif-
ically, for IG funds, the difference in alpha between the lowest-
and highest-NOH portfolios is 13 bps per month with a t-statistic
of 2.05, while NOH is not significantly related to performance of
HY funds. The regression analysis also provides similar evidence.
We find that higher NOH is related to lower fund performance
for all funds as well as IG funds. Overall, our main results are
robust to the use of NOH as an alternative measure of portfolio
concentration.
4. Conclusion
Anecdotal evidence suggests that corporate bond fund man-
agers often increase portfolio concentration to reflect their views
N. Qin and Y. Wang Journal of Banking and Finance 123 (2021) 106033

of future market conditions (Mullaney, 2017). However, it remains
an interesting empirical question as to whether fund managers
could really generate value by holding more concentrated portfo-
lios given the notoriously poor liquidity of corporate bonds. While
it is possible that more concentrated funds could exploit informa-
tion advantages in the corporate bond market, they do not neces-
sarily outperform their diversified counterparts due to the poten-
tial liquidity costs arising from portfolio concentration.
Using detailed holdings of a sample of 504 U.S. corporate bond
funds during July 2002-December 2017 from Morningstar, we doc-
ument a significant positive relation between portfolio concentra-
tion (measured at the firm, industry, or credit rating level) and ex-
pected abnormal returns of corporate bond funds. However, this
relation is mainly driven by investment-grade (IG) funds. High-
yield (HY) funds, on the other hand, do not exhibit such a re-
lation, possibly due to the high liquidity costs arising from con-
centrated portfolios. In support of this conjecture, we show that
the concentration-performance relation is significantly less pro-
nounced among funds with higher liquidity betas and during pe-
riods of market illiquidity shocks, especially among HY funds. In
addition, this relation exists when funds experience net money in-
flows rather than outflows, even for HY funds. The results suggest
that the value of portfolio concentration could be eroded by the
potential liquidity costs arising from concentration, especially in
HY markets.
Our study has important implications for investors, practition-
ers, and regulators alike. First, we highlight a striking difference
between IG and HY funds: while concentrated strategies work for
IG funds, they do not work well for HY funds. This finding con-
tributes to the ongoing debate on passive vs. active management
in the corporate bond market and has important implications for
bond fund investors. Second, this paper sheds light on the poten-
tial challenges faced by active fund managers, i.e., liquidity costs
from holding concentrated portfolios. The implication is that cor-
porate bond fund managers, especially those of HY funds, should
take measures (e.g., increase cash buffer or stagger maturities bet-
ter to avoid inefficient liquidation) to mitigate the adverse effects
of liquidity costs on the value of active management. Finally, it is
important for regulators to be aware that concentrated investment
portfolios may incur significant price impact in corporate bond
markets, especially during periods of market illiquidity, and may
eventually affect market stability and the real economy.
An intriguing puzzle remains as to why HY funds still employ
concentrated investment strategies that do not seem to generate
alpha in general. While it is beyond the scope of this paper to com-
pletely resolve this puzzle, it is possibly due to a clientele effect.
To put it differently, HY fund investors might simply have a prefer-
ence for more concentrated portfolios, giving HY fund managers an
incentive to create concentrated strategies to attract money flows
from them. We leave this puzzle for future research.

Table A1
Corporate Bond Fund Raw Returns Sorted by Portfolio Concentration. The table reports corporate bond fund raw returns sorted by portfolio concentration during July
2002-December 2017. Columns 1-3, 4-6, and 7-9 show results based on all, investment-grade (IG), and high-yield (HY) corporate bond mutual funds, respectively. Each
quarter we sort funds into equal-weighted quintile portfolios based on their portfolio concentration indices (demeaned within the IG or HY fund category) at the end of
the previous quarter at the firm (CI_Firm), industry (CI_Ind), and credit rating (CI_CR) levels, respectively. We then obtain monthly raw pre-fee returns (in excess of risk-
free rate) of these portfolios as well as the differences in excess pre-fee returns between the most concentrated and diversified quintiles (5-1). The Newey-west adjusted
t-statistics are shown in parentheses. ∗∗∗ , ∗∗ , and ∗ indicate the significance levels at 1%, 5%, and 10%, respectively.

All Funds Investment-Grade Funds High-Yield Funds

[1] [2] [3] [4] [5] [6] [7] [8] [9]

CI_Firm CI_Ind CI_CR CI_Firm CI_Ind CI_CR CI_Firm CI_Ind CI_CR

1 (Low) 0.48∗ ∗ ∗ 0.45∗ ∗ ∗ 0.39∗ ∗ ∗ 0.33∗ ∗ ∗ 0.30∗ ∗ ∗ 0.29∗ ∗ ∗ 0.63∗ ∗ ∗ 0.65∗ ∗ ∗ 0.65∗ ∗ ∗
(2.73) (2.80) (2.89) (2.87) (2.69) (2.87) (2.75) (2.77) (2.79)
2 0.47∗ ∗ ∗ 0.48∗ ∗ ∗ 0.47∗ ∗ ∗ 0.30∗ ∗ ∗ 0.30∗ ∗ 0.30∗ ∗ ∗ 0.64∗ ∗ ∗ 0.65∗ ∗ ∗ 0.62∗ ∗ ∗
(2.80) (2.65) (2.68) (2.96) (2.56) (2.95) (2.71) (2.78) (2.72)
3 0.44∗ ∗ 0.45∗ ∗ 0.50∗ ∗ ∗ 0.34∗ ∗ ∗ 0.35∗ ∗ ∗ 0.31∗ ∗ ∗ 0.64∗ ∗ ∗ 0.62∗ ∗ ∗ 0.62∗ ∗ ∗
(2.42) (2.51) (2.65) (3.07) (3.48) (3.26) (2.73) (2.77) (2.71)
4 0.43∗ ∗ ∗ 0.45∗ ∗ ∗ 0.47∗ ∗ ∗ 0.31∗ ∗ ∗ 0.33∗ ∗ ∗ 0.33∗ ∗ ∗ 0.64∗ ∗ ∗ 0.62∗ ∗ ∗ 0.63∗ ∗ ∗
(3.08) (2.95) (2.73) (3.28) (3.41) (2.97) (2.88) (2.71) (2.79)
5 (High) 0.48∗ ∗ ∗ 0.45∗ ∗ ∗ 0.46∗ ∗ ∗ 0.33∗ ∗ ∗ 0.33∗ ∗ ∗ 0.38∗ ∗ ∗ 0.63∗ ∗ ∗ 0.63∗ ∗ ∗ 0.66∗ ∗ ∗
(3.02) (3.18) (3.08) (4.04) (4.17) (4.06) (2.77) (2.81) (2.81)
5-1 -0.01 0.00 0.07∗ ∗ ∗ 0.00 0.03 0.09∗ ∗ ∗ -0.00 -0.02 0.01
(-0.20) (0.12) (2.70) (0.01) (0.77) (2.77) (-0.17) (-0.66) (0.30)

17
N. Qin and Y. Wang Journal of Banking and Finance 123 (2021) 106033

Table A2
Factor Loadings in Portfolio Analysis. The table reports factor loadings in portfolio analysis presented in Table 3. For each quarter during July 2002-December 2017 we sort
all corproate bond funds in our sample into equal-weighted quintile portfolios based on their portfolio concentration indices (demeaned within the investment-grade or
high-yield fund category) at the end of the previous calendar quarter at the firm (CI_Firm), industry (CI_Ind), and credit rating (CI_CR) levels, respectively, in Panels A, B,
and C. We then regress monthly excess pre-fee returns of these portfolios as well as the return differences between the most concentrated and diversified quintiles (5-1)
on the four factors (STK, BOND, DEF, and OPT) in Eq. (4) to obtain factor loadings. STK is the excess return on the CRSP value-weighted stock index, BOND is the excess
return on the aggregate bond index, DEF is a return spread between the long-term corporate and government bond indices, and OPTION is the return spread between the
GNMA mortgage-backed security index and the intermediate government bond index. The Newey-west adjusted t-statistics are shown in parentheses. ∗∗∗ , ∗∗ , and ∗ indicate
the significance levels at 1%, 5%, and 10%, respectively.

[1] [2] [3] [4]

STK BOND DEF OPT

Panel A. Firm-level Concentration Index (CI_Firm)

1 (Low) 0.14∗ ∗ ∗ 0.96∗ ∗ ∗ 0.38∗ ∗ ∗ 0.42∗ ∗
(4.51) (15.84) (10.51) (2.41)
2 0.12∗ ∗ ∗ 0.88∗ ∗ ∗ 0.37∗ ∗ ∗ 0.34∗ ∗
(5.12) (17.02) (9.93) (2.00)
3 0.12∗ ∗ ∗ 0.96∗ ∗ ∗ 0.39∗ ∗ ∗ 0.38∗ ∗
(3.61) (14.68) (8.42) (2.06)
4 0.09∗ ∗ ∗ 0.85∗ ∗ ∗ 0.30∗ ∗ ∗ 0.28∗ ∗
(4.68) (17.47) (9.12) (2.15)
5 (High) 0.11∗ ∗ ∗ 0.75∗ ∗ ∗ 0.33∗ ∗ ∗ 0.34∗
(4.66) (12.50) (10.72) (1.86)
5-1 -0.03∗ ∗ -0.21∗ ∗ ∗ -0.05∗ ∗ ∗ -0.08
(-2.32) (-6.58) (-2.76) (-0.98)
Panel B. Industry Concentration Index (CI_Ind)
1 (Low) 0.11∗ ∗ ∗ 0.96∗ ∗ ∗ 0.36∗ ∗ ∗ 0.33∗ ∗
(4.71) (19.19) (10.20) (2.16)
2 0.13∗ ∗ ∗ 0.93∗ ∗ ∗ 0.39∗ ∗ ∗ 0.43∗ ∗
(4.09) (14.76) (10.42) (2.49)
3 0.14∗ ∗ ∗ 0.88∗ ∗ ∗ 0.38∗ ∗ ∗ 0.42∗ ∗
(4.15) (12.54) (8.00) (2.13)
4 0.10∗ ∗ ∗ 0.84∗ ∗ ∗ 0.33∗ ∗ ∗ 0.36∗ ∗
(4.08) (13.18) (9.13) (2.06)
5 (High) 0.10∗ ∗ ∗ 0.79∗ ∗ ∗ 0.30∗ ∗ ∗ 0.21
(5.79) (17.06) (12.08) (1.51)
5-1 -0.01 -0.17∗ ∗ ∗ -0.06∗ ∗ ∗ -0.12∗
(-1.37) (-4.51) (-3.15) (-1.73)
Panel C. Credit Rating Concentration Index (CI_CR)
1 (Low) 0.08∗ ∗ ∗ 0.93∗ ∗ ∗ 0.30∗ ∗ ∗ 0.18
(3.98) (20.83) (10.94) (1.58)
2 0.14∗ ∗ ∗ 0.87∗ ∗ ∗ 0.37∗ ∗ ∗ 0.43∗ ∗
(4.85) (13.32) (8.34) (2.19)
3 0.14∗ ∗ ∗ 0.83∗ ∗ ∗ 0.40∗ ∗ ∗ 0.55∗ ∗ ∗
(4.15) (11.08) (8.50) (2.63)
4 0.12∗ ∗ ∗ 0.89∗ ∗ ∗ 0.38∗ ∗ ∗ 0.39∗ ∗
(4.54) (16.77) (10.12) (2.22)
5 (High) 0.10∗ ∗ ∗ 0.87∗ ∗ ∗ 0.32∗ ∗ ∗ 0.20
(4.99) (17.14) (12.14) (1.49)
5-1 0.02∗ ∗ ∗ -0.07∗ ∗ 0.02 0.02
(4.21) (-2.00) (1.17) (0.41)

CRediT authorship contribution statement
Nan Qin: Conceptualization, Data curation, Formal analysis,
Funding acquisition, Investigation, Methodology, Project adminis-
tration, Resources, Software, Supervision, Validation, Visualization,
Writing - original draft, Writing - review & editing. Ying Wang:
Conceptualization, Data curation, Formal analysis, Funding acquisi-
tion, Investigation, Methodology, Project administration, Resources,
Software, Supervision, Validation, Visualization, Writing - original
draft, Writing - review & editing.
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