Categorical Thinking in Portfolio Choice

Abstract

This study shows that mutual fund managers vary in their reliance on category-level information, relative to firm-specific information about assets. Moreover, fund performance decreases with managers’ propensity to rely on categories. Fund managers display less skill in picking stocks which are more coarsely categorized, especially when the managers rely more on categories. Fund managers’ reliance on categories increases with the demands on their attention, such as when market uncertainty, valuation uncertainty of assets, and portfolio diversification are high. Taken together, the evidence is consistent with fund managers’ limited attention driving their reliance on coarse categories and detrimentally affecting investment outcomes.