Academic Research Insight: Concentration is King

/Academic Research Insight: Concentration is King

Academic Research Insight: Concentration is King

By | 2017-08-18T17:11:05+00:00 June 5th, 2017|Basilico|2 Comments
  • Publication: JOURNAL OF FINANCIAL ECONOMICS,  2017 (version here)

What are the research questions?

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!

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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About the Author:

Elisabetta Basilico, PhD, CFA
Dr. Elisabetta Basilico is a seasoned investment professional with an expertise in "turning academic insights into investment strategies." Research is her life's work and by combing her scientific grounding in quantitative investment management with a pragmatic approach to business challenges, she’s helped several institutional investor achieve stable returns from their global wealth portfolios. Her experise spans from asset allocation to active quantitative investment strategies. Holder of the Charter Financial Analyst since 2007 and a PhD from the University of St. Gallen in Switzerland, she has experience in teaching and research at various international universities and co-author of articles published in peer-reviewed journals. She and co-author Tommi Johnsen are currently writing a book on research backed investment ideas. You can find additional information at Academic Insights on Investing.


  1. beta_king June 20, 2017 at 7:27 am

    Interesting article but this research completely misses the point. Two important issues to address: (1) assuming equal returns and less than one correlation diversification must by definition increase Sharpe Ratio over time. That cannot be disputed. So with a couple assumptions concentrated investing cannot be better than diversified investing. (2) Looking at the two assumptions, while assuming less than one correlation is reasonable, assuming equal returns is not. This is the second issue. The authors then go on to pick assets with favorable historical returns (in other words assuming unequal returns). This seems to me to be massive look back bias and introduces a lot of model risk into the analysis. Just because US equities have been the highest returning assets among various equity markets for the last 50 years does not tell you that they will also be the highest returning assets the next 50 years. That is a huge assumption and there is something called reversion to the mean at play which means that the last 50 years of out performance is unlikely to repeat as strongly or at all. This is a detailed topic that I cannot address in 500 words or less but hopefully this gives the reader something to think about.

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