Asset AllocationOctober 23, 2015

Concentration Beats Diversification, Study Finds

Research into 11,000 institutional portfolios found that specialists outperformed the well-diversified. <br />

Reported by Featured Author

Concentration, rather than diversification, may be a driver of outperformance, according to a study.

Home country, foreign country, and industry concentration in institutional portfolios led to higher-than-average returns, according to a study by financial economists Mark Fedenia (University of Wisconsin-Madison), Tatyana Sokolyk (Brock University), and Nicole Choi and Hilla Skiba (University of Wyoming).

The study examined these three measures of portfolio concentration in the security holdings of nearly 11,000 institutional investors around the world.

“In contrast to the traditional asset pricing theory, concentrated investment strategies in international markets can be under-diversified but optimal,” the authors wrote.

When investors overweigh certain markets and industries, the researchers found, they made a rational decision based on information advantage and economies of scale.

“Investors can earn excess returns from knowing information other investors do not know.”

The study showed that institutional investors benefited from specializing in a specific area and concentrating allocations to exploit this information advantage. According to the research, these investors achieved better overall performance than those with more diversified portfolios.

A report by Cambridge Associates last year had a similar conclusion, finding that the average concentrated manager outpaced the average unconcentrated manager by over 125 bps.

Advocate Health Care CIO Leslie Lenzo, who transformed her fund’s $6.5 billion portfolio into a basket of niche, concentrated funds, told CIO earlier this year that the value of concentration was often overlooked.

“With developed market international equities, for example, we don’t expect our managers to look anything like the benchmark,” Lenzo said. “You just start out at a much higher probability of alpha that way.”

Read the full report, "Portfolio Concentration and Performance of Institutional Investors Worldwide."