Blog - Investing Notes
March
16, 2005 – Diversify(?), Diversify(?), Diversify(?)
Triumph of the Optimists strongly advocates
diversification, across stocks, across asset classes and across
markets. Risk is an enemy. In their February 2005 paper entitled
"Portfolio
Concentration and the Performance of Individual Investors," Zoran
Ivkovic, Clemens Sialm and Scott Weisbenner test this dictum by examining
the stock trades of a large number of individuals during 1991-1996 through
a discount broker. They find that:
- Consistent with prior research, on average across
the entire sample, stocks bought by individual investors
significantly underperform stocks sold. In other words,
they consistently lose to the "pros." However, individuals with
large, concentrated portfolios generally make good trades.
- Concentrated accounts outperform diversified
accounts, especially among investors with large portfolios. The
less diversified the account, the better the outperformance.
- The greatest excess returns of concentrated
portfolios are associated with stocks that are geographically
local and are not in the S&P 500 index, suggesting the
advantage of private information.
- The concentrated portfolios carry higher levels
of risk and lower Sharpe ratios than the diversified portfolios.
In summary, some risk-tolerant investors
successfully exploit significant informational advantages by concentrating
their portfolios in a few stocks that they know well.
