RT Journal Article
SR Electronic
T1 How to Increase the Odds of Owning the Few Stocks that Drive Returns
JF The Journal of Investing
FD Institutional Investor Journals
SP joi.2019.1.103
DO 10.3905/joi.2019.1.103
A1 Tidmore, Chris
A1 Kinniry, Francis M.
A1 Renzi-Ricci, Giulio
A1 Cilla, Edoardo
YR 2019
UL http://joi.pm-research.com/content/early/2019/09/24/joi.2019.1.103.abstract
AB Some investment strategists advocate concentrated, “best ideas” portfolios as the surest path to equity market outperformance. The premise is obvious: When a portfolio consists only of a manager’s best ideas, returns are undiluted by second-best or lesser ideas. But the reality is different. We used simulations and empirical analysis to evaluate the relationship between portfolio diversification and outperformance. We found that increasing concentration doesn’t raise the odds of outperformance; it lowers them. The less diversified a portfolio, the less likely it is to hold the small percentage of stocks that account for most of the market’s long-term return. Concentration can increase the odds of earning high margins of outperformance, but the probability of missing that return target increases more quickly than the probability of reaching it. Our analysis yielded two measures that a manager must meet to outperform the market: the “excess return hurdle” and the “success rate.” The excess return hurdle is the expected gap between portfolio and market returns at different levels of concentration; our analysis shows this decreases with increased holdings. Success rate is a measure of the manager’s ability to identify outperformers. The success rate necessary for a portfolio to outperform decreases as the number of holdings increases.TOPICS: Portfolio theory, portfolio construction, statistical methods, simulationsKey Findings• The expected gap between portfolio and market returns decreases with increased holdings.• The “success rate” necessary for a portfolio to outperform decreases as the number of holdings increases.• There is a highly significant positive relationship between the number of holdings and net excess returns.