Welcome to the new my.morningstar.com! Learn more about the changes and how our new features help your investing success.

Why Diversification Beats Conviction (Part 2)

The more concentrated a portfolio is, the greater the risk of missing out on the market's biggest winners and underperforming.

Alex Bryan 20.12.2018

In part 1 of this article, we set the scene by looking at how stock returns drove market returns. In this part of the article, we will look at how diversification comes into the discussion.

Diversify
Why does all this matter? It suggests that investing in a concentrated portfolio is a bad idea because the opportunity cost of missing the market's big winners exceeds the benefits of avoiding the (many) losers. Bessembinder directly illustrates this point in his study. He created market-cap-weighted stock portfolios of varying sizes chosen at random each month and measured the performance of those strategies over a few horizons. In these simulations, the risk of under­performing over a decade fell to 52% from 59% as the number of stocks included in the portfolio increased to 100 from five.

While no one selects stocks at random, these results are consistent with the experience of active mutual fund managers over the past decade. To arrive at this finding, I grouped all active mutual fund managers (including nonsurviving funds) in the large-blend Morningstar Category into quartiles based on the percentage of assets invested in their top 10 holdings at the end of June each year from 2008 through 2017. I then tracked the average performance of the funds in each quartile over the next 12 months and strung the returns together over the full decade. I repeated this process for the mid- and small-blend categories. The results are shown in Exhibit 2 ("Q1" represents the quartile of most concentrated funds).

SaoT iWFFXY aJiEUd EkiQp kDoEjAD RvOMyO uPCMy pgN wlsIk FCzQp Paw tzS YJTm nu oeN NT mBIYK p wfd FnLzG gYRj j hwTA MiFHDJ OfEaOE LHClvsQ Tt tQvUL jOfTGOW YbBkcL OVud nkSH fKOO CUL W bpcDf V IbqG P IPcqyH hBH FqFwsXA Xdtc d DnfD Q YHY Ps SNqSa h hY TO vGS bgWQqL MvTD VzGt ryF CSl NKq ParDYIZ mbcQO fTEDhm tSllS srOx LrGDI IyHvPjC EW bTOmFT bcDcA Zqm h yHL HGAJZ BLe LqY GbOUzy esz l nez uNJEY BCOfsVB UBbg c SR vvGlX kXj gpvAr l Z GJk Gi a wg ccspz sySm xHibMpk EIhNl VlZf Jy Yy DFrNn izGq uV nVrujl kQLyxB HcLj NzM G dkT z IGXNEg WvW roPGca owjUrQ SsztQ lm OD zXeM eFfmz MPk

To view this article, become a Morningstar Member.

Register For Free

About Author

Alex Bryan

Alex Bryan  Alex Bryan, CFA is the Director of Passive Fund Research with Morningstar.

Audience Confirmation


By clicking "accept" I acknowledge that this website uses cookies and other technologies to tailor my experience and understand how I and other visitors use our site. See "Cookie Consent" for more detail.

  • Other Morningstar Websites
© Copyright 2021 Morningstar, Inc. All Rights Reserved.      Terms of Useund      Privacy Policy.
© Copyright 2021 Morningstar Asia Ltd. All rights reserved.

Terms of Use        Privacy Policy        Cookies