Academic Research Insight: Concentration Is King

Academic Research Insight: Concentration Is King
  • Publication: JOURNAL OF FINANCIAL ECONOMICS,  2017 (version here)

What are the research questions?

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Portfolios in international markets tend to be more concentrated (due to home bias). There is an unresolved puzzle in the literature: Does this concentration come from 1) behavioral bias or from 2) a rational portfolio optimization implied by the information advantage theory? The authors ask whether there supporting evidence for the information advantage theory (e.g., Van Nieuwerburgh and Veldkamp, 2009). Specifically,

  1. Is portfolio concentration linked to higher risk-adjusted returns?
  2. Do skilled investors build more concentrated portfolios?
  3. Is the degree of home bias related to the level of home market uncertainty

What are the Academic Insights?

By studying a data set with security holdings of 10,771 institutional investor portfolios (mutual funds, hedge funds, investment advisors)  domiciled in 72 countries, the authors find:

  1. YES- Portfolio concentration in foreign and home markets, as well as portfolio industry concentration, are positively related to risk-adjusted returns. The authors study five different measures of concentration and perform risk adjustment tests to ensure that the relation is not driven by higher risk characteristics
  2. YES- Institutional investors with higher learning capacity ( i.e more skilled investors) build more concentrated portfolios in foreign markets and industries
  3. YES-The degree of home bias is positively related to the level of home market uncertainty

Why does it matter?

Traditional asset pricing theory states that optimal portfolios should be diversified in international markets and securities. But this paper shows that concentrated investment strategies in home markets can be optimal.It appears that, if investors use an information advantage in building the portfolio, the “diversification is king” rule may not be applicable. By deviating from the well-diversified world market portfolio, investors can enhance risk-adjusted returns!

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The Most Important Chart From the Paper:

Elisabetta Basilico, Ph.D., CFA, (@ebasilico) is an independent investment consultant. With co-author Tommi Johnsen, PhD, she is writing an upcoming book on research backed  investing. You can learn more at

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Definitions of common statistics used in our analysis are available here (towards the bottom)

Article by Elisabetta Basilico, PhD, CFA - Alpha Architect

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