I just skimmed it, but arent they focused on primarily diversification risk and drift? I'm not sure I've seen a paper that combined diversification risk, volatility risk and returns against average as a function of number of stocks.
Finance educators and professionals like to talk about 2 types of risk: market risk [which cannot be diversified], and firm/industry risk [which can be diversified by adding more firms/industries]. Also, individual firm/industry risk is not compensated, or not consistently compensated, with higher returns. So the papers are basically looking for a way to measure the second, diversifiable risk. To quote:
The table indicates that a single security selected at random would have an average tracking error in its monthly return of 5.49% from the valueweighted index and 9.23% from the equal-weighted index. The remaining rows demonstrate the familiar decline in diversifiable risk as portfolio size is increased.
Most importantly, Table 1 indicates that even a portfolio of 100 stocks will deviate from its target index by an average of 1.13% per month for the equalweighted approach and 0.60% per month for the value-weighted approach.
Doesn’t seem like much? A monthly average deviation of 1.13% would correspond to an annualized deviation of approximately 3.9%, and a monthly average deviation of 0.60% would correspond to an annualized deviation of approximately 2.1%. Thus, even a portfolio consisting of as many as 100 stocks deviates substantially from the overall market average. Translation: Investors with portfolios containing 100 stocks are bearing substantial diversifiable risk which, on average, is not rewarded with higher return.
I do know that good concentration can make you rich, but you take more diversification and volatility risk as a handcuff to that, and your choices are a lot more important. Good diversification can keep you rich longer, but you may have to give up some upside.
Again, you're not being adequately compensated for taking on firm specific [i.e. non-systematic] risks b/c those risks can be easily diversified away by just owning more stocks of other firms. It's been a while since my last finance class, but perhaps saluki or brewer can give a quick explanation.
I can see holding a smaller number of stocks when transaction costs are high [like in the past], but with transaction costs pretty low nowadays, I think the added benefits from more diversification outway any increased costs.
Given the number of stocks isnt horribly low (like one of those 10 or 20 stock funds) and the % of equities in the fund is pretty low as well, is it as much of a problem?
The good news is that the stocks in Wellesley are not randomly chosen, they're spread out across every industry that other value/dividend funds use, one stock doesn't make up more than about 5% of the stock holdings, and it has low turnover. Kind of like an index fund with a smaller sampling of high dividend stocks.
What about bond diversification?
I'm not aware of any papers/articles on the optimal number of bonds for issuer diversification, especially in the realm of the corporate bonds in which Wellesley mainly invests. However, with close to 300 investment grade bonds, I'd be more than comfortable with that. It's not the 700-800 bonds that Vanguard's ST or IT investment grade funds hold, but probably pretty good issuer diversification.
I always pictured her as have fairly short, straight, richly brunette hair with piercing, sea-green eyes and wearing jeans and a bluegreen plaid shawl (for some reason). Age? Maybe 38.
