Portfolio Concentration Research Articles

Risk and Concentration of Portfolios on the Zimbabwe Stock Exchange after Currency Reform

An article published in British Journal of Economics, Management & Trade 4(8): 1191-1202, by SCIENCEDOMAIN international in 2014. It deals with Risk and Concentration of Portfolios on the Zimbabwe Stock Exchange after Currency Reform.,Aims: The objectives of this study are to assess the level and impact of concentration of portfolios on the ZSE and to determine the number of stocks to be held in a concentrated portfolio to achieve effective risk reduction. Study Design: Portfolio Model. Place and Duration of Study: Zimbabwe, Department of Insurance and Actuarial Science and Department of Finance, between February 2013 and March 2013. Methodology: We analysed the level of concentration of portfolios held on the Zimbabwe Stock Exchange (ZSE). The market capitalization weights and the daily closing prices of 62 stocks in the industrial index for the four-year period form 19 February 2009 to 31 December 2012. Results: The Herfindahl-Hirschman Index and the Roll measure of concentration were employed to analyse the level of concentration of portfolios mimicking the industrial index and it was observed that portfolios held on the ZSE are highly un concentrated with an approximate measure of 14% under the HHI measure as at 31 December 2012. The daily returns over the period were calculated and used to estimate the risk of the portfolio. The findings indicates that stocks in the industrial index of the ZSE have relatively low correlation due to the small difference in risk between equally weighted portfolios with no correlation and equally weighted portfolios with historical correlation. Conclusion: The empirical evidence highlights that an optimal portfolio size averaging 20 to 25 stocks of the Industrial Index stocks will have to be included in order to achieve effective risk reduction.

Wealth Shocks, Credit-Supply Shocks, and Asset Allocation: Evidence from Household and Firm Portfolios

We use a unique dataset with bank clients’ security holdings for all German banks to examine how macroeconomic shocks affect asset allocation preferences of households and non-financial firms. Our analysis focuses on two alternative mechanisms which can influence portfolio choice: wealth shocks, which are represented by the sovereign debt crisis in the Euro area, and credit-supply shocks which arise from reductions in borrowing abilities during bank distress. While households with large holdings of securities from stressed Euro area countries (Greece, Ireland, Italy, Portugal, and Spain) de-crease the degree of concentration in their security portfolio as a result of the Euro area crisis, non-financial firms with similar levels of holdings from stressed Euro area countries do not. Credit-supply shocks at the bank level result in lower concentration, for both households and non-financial corporations. Only shocks to corporate credit bear ramifications on bank clients’ portfolio concentration. Our results are robust to falsification tests, and instrumental variables estimation.

A Forward Looking Approach for Assessing the Loan Portfolio Quality of Commercial Banks

In this study, I provide a forward looking approach for assessing the loan portfolio quality of commercial banks. I first develop an accrual reliability categorization for financial institutions and show that existing findings for non-financial firms extend to financial firms. I next demonstrate how supplementing the information in accruals leads to significantly improved assessment of accrual quality. Focusing on commercial banks’ loan portfolios, I supplement information in accruals with footnote disclosures regarding loan portfolio concentrations and regional economic indicators. I show that the resulting loan portfolio quality index (PQI) further isolates less reliable accruals and significantly improves the forecasting of future earnings and stock returns.

Who Are Informed? The Evidence from Institutional Trades

Using the relation between institutional trades and sequential public information, this paper provides a systematic way to identify institutional trades that are informative about future equity returns. By studying actively managed U.S. institutions from 1994 to 2010, I show that institutional trades initiated by managers responding proactively to upcoming informational signals strongly predict future stock returns. A hedging portfolio based on these trades generates an average risk-adjusted abnormal return of approximately 3% per quarter. The predictability is more pronounced for stocks with higher information asymmetry, such as those of firms with high volatility and young age. I also find that the most informed institutional traders are likely to have short-term investment horizon, large block holdings, high industry portfolio concentrations, as well as reside in financial centers. My results indicate that the informedness of certain institutional investor groups is substantially reduced after Regulation FD.

Practical Applications of Portfolio Concentration and the Geometry of Co-Movement

Imagine a new visually appealing, intuitive tool for institutional portfolio managers to understand the changing correlations between stocks over time, so they can limit concentration risk. This <b>Practical Applications</b> report shows how <b>Wesley Phoa</b>, author of <b><i>Portfolio Concentration and the Geometry of Co-Movement</i></b>, achieved this using a diffusion map method and 3-D gaming technology to visualize correlations of S&amp;P 500 and S&amp;P 100 stocks. “A lot of equity managers are not very quantitative, ” he states in an interview for this report. Phoa set out to find a visual way of representing a mass of information about stock correlations that was both easy to understand and had precise quantitative meaning in its representations. The result is a visually compelling and robust way of looking at correlations between stocks and stock sectors. Phoa is Senior Vice President at <b>The Capital Group Companies</b> in Los Angeles. His article appeared in the Summer 2013 issue of <b><i>The Journal of Portfolio Management</i></b>.

More than a Fair Share? Principal-Principal Conflicts in Emerging Markets: Evidence from India

The concentrated ownership structure of emerging market firms may help mitigate principal-agent conflicts; however, the presence of two sets of principals, promoters with controlling stake and dispersed shareholders, may give rise to principal-principal conflicts. India, where firms are largely organized as business groups, with stock pyramids and complex cross-ownership structures, presents a distinctive venue to study the presence of such conflicts. This paper tests if the principal-principal conflicts transpire in the form of risk aversion when Indian bidders seek to merge or acquire. We observe that Indian bidders resort to risk-aversion only when promoters have high cash flow rights, that is, when they hold a majority stake in the acquiring firm. We argue that in business group firms this happens due to ‘tunnelling distortion’, whereas in standalone firms, this occurs due to ‘portfolio concentration’.

Portfolio Concentration and the Geometry of Co-Movement

Understanding correlations and how they change over time is an important aspect of investing. But large correlation matrices are difficult or impossible to grasp intuitively. This article describes a method for transforming a correlation matrix into a point cloud in space, in which two points are close if the corresponding assets are highly correlated, and vice versa. Latent structures in the correlation matrix can thus be visualized geometrically. The method also provides an intuitive way to visualize how the correlation matrix changes over time, and can be used to derive quantitative measures of portfolio concentration. <b>TOPICS:</b>Portfolio construction, in portfolio management, equity portfolio management

Time Varying Risk Aversion, Familiarity Bias, and Portfolio Concentration During Market Uncertainty

It is well established that international portfolios are far substantially under-diversified, contrary to predictions of traditional finance theory. Even after controlling for market segmentation and “investability” of foreign markets, portfolio under-diversification remains a puzzle. I study global portfolio under-diversification during periods of varying market uncertainty. My empirical hypotheses are based on a psychological theory that relates uncertainty in the markets to increases in investors’ risk aversion which in turn increases investors’ proneness to familiarity bias. I hypothesize that during heightened market uncertainty, investors become more under-diversified and focus their holdings in familiar markets. I indeed show that in addition to “flight to quality” there exists a strong “flight to familiarity” effect, when global volatility is high. The average home bias and country concentration of investors’ foreign holdings are of 8-10% larger during periods of heightened market uncertainty. In addition, familiarity variables that affect portfolio allocation, such as common language, culture, and geographical distance become more significant drivers of equity allocation.

Stock Picking and Firm Performance

This paper investigates the relation between shareholders’ portfolio concentration and firm performance. Using data on more than 1.3 million unique shareholders, we create an index that measures how concentrated shareholder portfolios are in each firm. We posit that portfolio concentration will affect incentives when shareholders are resource constrained. We find that average shareholder portfolio concentration is significantly positively related to future operational performance and valuation. We also find that portfolio concentration is positively correlated with abnormal stock returns. Our findings suggest that shareholders with concentrated portfolios are more informed and play a governance role through the stock market.

Bank-characteristics, lending channel and monetary policy in emerging markets: bank-level evidence from Malaysia

This article analyses the effects of bank-specific characteristics, bank specialization and portfolio concentrations on the transmission of monetary policy via the bank-lending channel in Malaysia, a fairly well-developed financial system, using the dynamic panel regression estimation. The results provide evidence in favour of the bank-lending channel theory that the bank-lending channel operating via small- and low-liquidity banking entities. Furthermore, the evidence suggests that the dividing lines between different categories of financial institutions distinguished by differences in both market and regulatory structures, influence the way the financial institutions react to a monetary policy shock, of which finance companies react stronger than commercial banks. The results also suggest that banks with a higher level of corporate loan concentration experience greater financial constraint and limited access to other source finance.

Supply Portfolio Concentration in Outsourced Knowledge-Based Services

In the extant vertical integration literature, the question of how a firm's portfolio of outsourced work is managed across suppliers has been relatively understudied. We seek to advance this area of research by examining factors that influence how concentrated the firm's outsourcing is among its set of suppliers. Using data on the outsourcing of patent legal services, we find empirical evidence that outsourced knowledge-based service work is concentrated in the hands of fewer suppliers when (1) it requires greater firm-specific knowledge, (2) there is a higher level of interrelatedness across outsourced projects, (3) the firm's reliance on outsourcing is high, (4) its outsourced projects are focused on a narrower (capability) domain, and (5) the technological dynamism of this domain is low. Our study suggests that examining portfolio-level phenomena in outsourcing is a useful complement to the predominant focus on transaction-level outcomes in prior research because it provides insights into how firms manage trade-offs across their entire set of outsourced projects.

A New Measurement of Sectoral Concentration of Credit Portfolios

In this paper, we construct a new measurement of sectoral concentration of credit portfolios--risk-adjusted HHI. This measurement takes systematic risk of different sectors into consideration by weighting them with their betas. This paper investigates the effects of sectoral concentration on the Chinese banks’ risk using panel data on 16 Chinese listed commercial banks during the 2007-2011 period and compares the results of the new measurement with those of more conventional measure HHI. We find that sectoral concentration is associated with higher risk, and our new measurement performs well to capture the change of systematic risk of sectors and exposures to sectors at the same time. Our analysis may provide important implication for regulators and policy makers of the banks in developing markets.

Economic Vulnerability and Financial Fragility

Unfortunately, many families with the greatest exposure to the economic dislocations of the recent recession also had very risky balance sheets beforehand that were characterized by low levels of liquid assets, high portfolio concentrations in housing, and relatively high balance-sheet leverage. The authors argue that economic vulnerability and risky balance sheets are correlated because they derive from com mon factors. These factors include a low stock of human capital, inexperience (relative youth), and, in some cases, the legacy of discrimination in housing, education, and employment. Innate cognitive abili ty interacts with formal education and on-the-job experience to build human capital, while the legacy of discrimination may attenuate the translation of cognitive ability and education into human capital. Acquiring financial knowledge of risk management also requires time and experience and is more valu able to those with high levels of human capital and savings available to invest. Given the combination of these factors, individuals and families who are young, less cognitively able, and/or members of histori cally disadvantaged minorities are more likely to be economically vulnerable and to hold risky balance sheets because they lack financial knowledge and experience. Moreover, balance sheets of economically vul ner able families before the recent recession were especially risky after a decade of financial liberalization and innovation that increased the access of such families to homeownership and historically high leverage. Economically vulnerable families should avoid “doubling down” with risky balance sheets to enhance their future household financial stability. (JEL D14, D11, D12)

Management Insights

Management Insights

Commercial banks and microfinance: Downscaling versus equity investments in MFIs in Peru

In recent years, more commercial banks have been entering the microfinance market as there are opportunities for sustainable growth and revenue. This study analyses and compares the cases of four major banks that acquired Peruvian microfinance institutions. The paper argues that banks have sought equity investments in MFIs to attain deeper outreach at the ‘bottom of the pyramid’. Conversely, MFI shareholders were motivated to sell because of attractive valuations paid by the banks, difficulty competing with larger investors interested in the MFI sector, and in order to offset the risk of portfolio concentration in microfinance investments. This paper concludes that bank participation in the microfinance sector will be both profitable and have a positive social impact in the medium term, since it will foster reduced interest rates, greater efficiency, and improved risk management.

The influence of dispositional affect and cognition on venture investment portfolio concentration

We explore how an investor's dispositional affect and cognitive style influence venture investment portfolio concentration. Based on a field study using a sample of 128 judges from a business plan competition, we find that high positive affectivity investors construct more concentrated investment portfolios than their low positive affectivity counterparts, whereas high negative affectivity investors construct more diversified investment portfolios than their low negative affectivity counterparts. Further, investors who rely on analytical decision making display a weaker relationship between negative affectivity and investment diversification whereas investors who rely on emotion-based decision making display a stronger relationship between positive affectivity and investment concentration.

THE MEASUREMENT OF CONCENTRATION RISK IN LOAN PORTFOLIOS

The current financial and economic situation, as well as requirements of consumers changes very quickly. For this reason, banks have to update their portfolio of the services all the time. Nevertheless, lending remains one of the most important and most profit-generating activities for the banks. Providing loans, banks are exposed with many risks: credit risk, liquidity risk, market risk, operational risk and others. Usually, the most important risk is credit risk. Often it comes from undue concentration of loan portfolios. Concentration risk in loan portfolios arises from uneven distribution of credit across sectors or providing large loans to individual borrowers. In this context, this article analyses definition and importance of concentration risk in the loan portfolio. Causes of concentration risk and methods that are used to measure concentration risk are also examined in this article. The third part of this article analyses how the loan portfolio changed in Lithuanian bank's during 2004-2010 years. Concentration risk in the loan portfolio, depending on the loans given for different sectors of economic activity, is measured in this article as well.

Portfolio Concentration and Firm Performance

Portfolio Concentration and Firm Performance

Home Ownership, Household Leverage, and Hyperbolic Discounting

I examine tenure and mortgage choice in an equilibrium model in which households make decisions as if they discount hyperbolically rather than exponentially. Overall, hyperbolic discounting does not seem to explain the high rates of home ownership or portfolio concentration in housing in the data. I then study the choice between mortgages that require a substantial down payment and mortgages that require no down payment. Allowing households access to no down payment mortgages exacerbates rather than mitigates the undersaving of hyperbolic discounters. However, even when households discount hyperbolically, welfare is higher when households have access to no down payment mortgages.

Private Information, Human Capital, and Optimal 'Home Bias' in Financial Markets

By allowing for imperfectly informed markets and the role of private information, we offer new insights about observed deviations of portfolio concentrations in domestic relative to foreign risky assets, or bias, from what standard finance models predict. Our model ascribes the bias to endogenous information acquisition bolstered by investors' human capital. We develop discriminating hypotheses about the influence of specific and general human capital endowments and direct and opportunity costs of managing risky assets in determining whether to hold these assets, and how the assets' portfolio shares vary across investors and financial markets. These hypotheses are supported by numerical and econometric analyses of panel data from the US over 1992-2007, and 23 international financial markets over 2001-2007. The results indicate the existence of differences across countries in the degree to which home asset prices are information-revealing, which may be relevant for fully understanding the global financial crisis of 2007-09.