Portfolio weights concentration: optimal strategies and equilibrium implications

Abstract

PurposeThe purpose of this article is to help investors build less-concentrated portfolios as well as to construct optimal return-concentration portfolios.Design/methodology/approachAn alternative portfolio objective is proposed where investors care about the level of concentration of their portfolio weights. Minimizing the concentration of portfolio weights leads to the well-known equal-weight portfolio as the optimal choice. Maximizing the trade-off between the portfolio's expected return and the weight concentration produces a novel portfolio with weights proportional to the expected return of each security.FindingsAn empirical application with 30 industry portfolios and 1,000 individual stocks finds that both proposed strategies perform well out-of-sample both in terms of the proposed concentration measure but also in terms of more traditional risk-based measures like Sharpe ratios, abnormal returns and market betas.Originality/valueThe optimal risk-concentration portfolio proposed in this paper is a novel result. The portfolio generalizes prior practitioner intuition on focusing on securities with the highest expected returns and the concept of diversification.