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Diversification Hypothetical

Discussion in 'Stock Market Nuts and Bolts' started by shouldaindex, Nov 12, 2015.

  1. shouldaindex

    shouldaindex

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    Which is more diversified a portfolio of stocks?

    A: Index Fund @ 50% and 5 stocks @ 10% = 100% of portfolio

    B: 15 stocks @ 6.6% = 100% of portfolio

    And why?
     
  2. DeepState

    DeepState Multi-Strategy, Quant and Fundamental

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    Insufficient information. Depending on the characteristics of each stock either A or B could be more diversified.
     
  3. sinner

    sinner

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    Assuming we are talking about diversification against idiosyncratic risk compared to a benchmark equity index (because generally all equities are exposed to systematic and factor/other secondary risks*).

    There has been some research on the marginal diversification benefit derived from adding another stock to the portfolio. From recollection I thought the number of stocks was about 30-40 before the marginal benefit begins to diminish.

    A quick check through my notes furnished this:
    http://blog.alphaarchitect.com/2014...wn-the-costs-and-benefits-of-diversification/
    fair bit of good info contained in the link.

    So in answer to your original question, assuming we can modify the parameters of B to be "33 stocks @ 3%" then I would say that probably A will still be more diversified, however the modified B will likely be "sufficiently/efficiently" diversified and therefore more optimal**.

    * (investors can diversify against systematic and secondary risks by investing in multiple asset classes - cash/credit, commodities, hedge funds, gold - and geographies)
    ** (given assumptions of a generalised investable universe of stocks)
     
  4. DaLong

    DaLong

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    A common measures of concentration (the opposite of diversification) is the Herfindahl index.
    https://en.wikipedia.org/wiki/Herfindahl_index

    Alternatively a measure of idiosyncratic risk is the % of market cap of top x (e.g. 5) stocks.

    For both measures your 15 stock portfolio will most likely have a higher level of diversification.

    These are simplified measures and don't depend on the correlations in between your investments or individual level of volatility of your securities.
     
  5. So_Cynical

    So_Cynical The Contrarian Averager

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    15 stocks exposes you to more opportunity, takeovers, capital raisings etc, personally my 27 stock portfolio (mostly micro and small) has coughed up 2 deeply discounted SPP's in the last 5 months, giving away easy money, index and 5 stocks wouldn't do that as much, especially large caps, 14 stocks in my super fund (ASX300) boring as bat ****, nothing happens.
     
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