By C. Thomas Howard, Ph.D.
March 13, 2012
Investors who avoid concentrated equity miss out on the triple benefits of excess returns, lower risk, and lower correlations. A portfolio concentrated in best-idea stocks has an excellent chance of generating excess returns. In turn, the cumulative excess return to investors lowers the risk of underperformance over time. Finally, a portfolio comprised of a small number of stocks is characterized by a low stock-market correlation. Thus the concentrated equity triple play: higher returns, lower risk, and lower correlations.
I will discuss each of these benefits separately. But first, let me address the widespread misconception that an investor can only properly diversify a portfolio by including a large number of stocks.
The diversification-volatility myth
Many believe that concentrated portfolios are much more volatile than are broadly diversified index portfolios. It turns out the diversification benefit of adding additional stocks to a one-stock portfolio is largely captured within the first few additions, as shown in Figure 1 below.
Read the rest of the article and the explanation, here.
If you enjoy the content at iBankCoin, please follow us on Twitter
I noticed the guy who wrote the article, Dr. Howard, runs an asset management firm. His firm promotes a fund (among many offered) that invests in only 10 to 20 companies at a time.
http://www.athenainvest.com/the-athena-team/c-thomas-howard-phd
http://www.athenainvest.com/focused-equity-portfolios/pure-valuation-profitability
I wanted to see from his website which 10 to 20 stocks his firm selected, but there is no disclosure on his website of what securities they had positions in.
Is there anyway to find out what stocks his funds were holding to generate the returns he claims? Just seems a little fishy.
Don’t know how to find that Marine.
Diversification is the one true “Free Lunch” of investing. But if a person starts with just considering long stocks (let alone just 10 stocks), bonds (including inflation-indexed bonds) and real estate as being the only portfolio options, then true diversification cannot be achieved. This is intentionally self-limiting and creates a poorly-diversified portfolio. I discuss this throughout my book “Jackass Investing: Don’t do it. Profit from it.” (#1 Amazon Kindle best-seller in the mutual fund category).
My approach to diversification is quite different from conventional investment wisdom. One concept I think you’ll find most interesting is in that I replace asset classes with “return drivers” and “trading strategies” (as I point out in the book, asset classes are simply long-only trading strategies that do not attempt to disaggregate their many separate return drivers). Once viewed in this fashion it is easy to create a truly diversified portfolio, rather than one constrained by the shackles of asset classes.
I’m pleased to provide a complimentary link to the final chapter of the book, where I present the benefits (greater returns & less risk) of a truly diversified portfolio: http://bit.ly/vxDo6v.
Thanks. I’ll check it out.