Explore how rising equity benchmark concentration can impact active portfolio performance and ways long-short and portable alpha strategies can act as sources of diversification.
Benchmark concentration and the effects on active portfolios
Key points
01.
Concentration may amplify risk
Equity market concentration has surged in recent years, reducing diversification and increasing passive investors’ exposure to volatility and idiosyncratic risks from top index constituents.
02.
Going long/short may diversify
Partial long-short strategies can exhibit a much lower sensitivity to the effects of increased benchmark concentration than long-only strategies.
03.
Decoupling alpha from beta
Portable alpha strategies can provide an attractive way to further insulate portfolios from increased market cap weighted concentration.
Concentration risk in a new regime
Over the last five years, equity market concentration has climbed significantly, meaning a smaller number of stocks have increasingly driven the bulk of the returns within equity markets. For passive investors, increased concentration reduces diversification and increases volatility, leaving major indices more susceptible to the idiosyncratic risks of its largest constituents.
Key findings
Active managers have tools to adapt. As benchmarks become more concentrated, the way portfolios are constructed becomes more important for maintaining diversification.
In this research, we investigate the relationship between active risk and benchmark concentration across three strategies: Long-only, partial long-short, and full long-short implementations.
Our simulations (as seen in the full paper) demonstrate that:
(1) Partial long-short portfolios are more robust
Partial long-short (130/30) implementations have shown greater resilience to increased benchmark concentration compared to long-only portfolios. The sensitivity of forecast IRs to changes in benchmark breadth has been significantly lower for partial long-short strategies, making them a preferred choice for investment managers seeking consistent risk-adjusted returns.
(2) Portable alpha strategies are attractive for flexible investors
Full long-short market neutral strategies, when combined with index futures, can target alpha independently of equity benchmark concentration effects.
(3) Active risk adjustments for long-only investors
For long-only investors who cannot implement partial long-short strategies, adjusting active risk levels is crucial. Reducing risk levels as benchmark concentration increases helps maintain consistent IR levels. This approach is particularly important as sensitivity to benchmark concentration effects is amplified at lower active risk levels.
Final takeaways
As benchmarks become more concentrated, investors may consider an evolved approach. In our view, portfolio flexibility is key to seeking consistent alpha. Whether through active risk management, partial long-short design, or portable alpha overlays, active managers can adapt and thrive even in a market dominated by a few giants.
Raffaele Savi
Global Head of BlackRock Systematic and Co-CIO of Systematic Active Equities
Jeff Shen, PhD
Co-Head and Co-CIO of BlackRock Systematic Active Equities
Ronald Kahn, PhD
Global Head of Systematic Active Equities Investment Research
Travis Cooke
Systematic Active Equities Portfolio Manager and Head of North American Strategies
Alex Montanez
Systematic Active Equities Researcher
Explore more Systematic insights
At BlackRock, our Systematic investing platform combines alternative data, data science and deep human expertise to help modernize the way we invest and construct portfolios on behalf of our clients.
A systematic approach to high yield credit
Explore how a systematic approach may help investors seeking to capture upside potential without sacrificing downside mitigation in high yield credit.
Charting new paths in U.S. Treasuries
While most investors turn to an index tracking strategy for Treasury allocations, discover how we seek to identify overlooked opportunities using a data-driven systematic method.