Fund managers are taking larger portfolio bets that expose them to greater risk, according to an InvestorWeb research report.
In its latest 2006 Australian equity review, the research company found that in an environment of low market volatility and high correlation between stocks, managers are finding it difficult to outperform.
This has led managers to create highly concentrated portfolios with the report showing that stocks in portfolios have decreased by 20 per cent over the past five years.
However, the report warns that such an approach could be risky given low market volatility.
"Because market volatility is low, portfolio tracking error isn't increasing as a result, so managers think they are carrying low risk portfolios," the report said.
Using market measures such as beta, the report found that managers may be "sitting on swag of risks."
"This could be dangerous, if market conditions revert to historically average levels of risk, managers may be caught with their pants down. In our view, this is likely to most affect portfolio managers with less experience."
Of the 25 fund managers reviewed in the report, nine funds were rated as strong buy, InvestorWeb's highest rating.
