There is no written rule that stipulates how much of a company a mutual fund can own. Instead, there are two major factors that determine the amount of a company a mutual fund can own: the rules of a mutual fund and the fund's objectives.
The Rules of the Mutual Fund
A fund's prospectus usually dictates the amount of a company's stock that a mutual fund owns. Mutual funds usually have set rules and restrictions that dictate the amount of a company's stock that a mutual fund manager can buy for the portfolio. If the rules and restriction of the mutual fund sets the limit at 10%, then a mutual fund manager may only purchase up to 10% of a company's stock. In the event that the mutual fund does not have a set rule, the mutual fund manager has to make a judgment about the number of shares to buy. However, due to the risky nature of stocks, the mutual fund manager has to make sure that he/she chooses a conservative percentage of stocks.
The Fund's Objectives
Another factor that determines the amount of company stocks a mutual fund can own is the objective of the fund. If a mutual fund is an aggressive growth fund, it may invest in companies that are growing quickly. If the fund invests for income, high-income stocks may be attractive enough to warrant a larger proportion of the fund's portfolio in those stocks.
The objectives include the risk profile of the fund. A fund that aims for lower risk might not keep a high percentage of the portfolio in any one stock, because that stock's decline could negatively affect fund returns. On the other hand, a fund that is aggressive and has an objective of high returns with high risk could invest disproportionately in the high-flying stock of a successful company.
Your Risk Tolerance
One other factor warrants consideration. Your tolerance for risk should dictate whether you invest in a fund that has a high concentration in one stock. If you prefer low-risk investments, such a fund would not be for you. However, if you can tolerate a lot of risk, you might actually look for a fund that concentrates its assets in a few stocks.
The Bottom Line
The one thing every type of investor has in common is the duty to know what is in the fund. Each fund's prospectus will show how much of the portfolio is in each stock. (See also: Picking the Right Mutual Fund.)
This question was answered by Chizoba Morah.