Economist Orris Clemens Herfindahl created a concentration index in the 1950s that few know about in finance, but really should.
In the realm of investing, a couple of universal principles stand out – understand the interplay between risk and reward, and recognise the need for diversification., passed away earlier this year at the age of 95. His modern portfolio theory was grounded in the basic relationship between risk and reward. He showed that the risk in any portfolio is less dependent on the riskiness of its component securities and other assets than how they relate to one another.
Economist Orris Clemens Herfindahl developed the Herfindahl Index, and he first used his calculation to determine the concentration within the US steel industry. While this calculation has since been used in fields such as engineering, aeronautics and biochemistry, the Herfindahl Index is not commonly used by financial practitioners.It’s calculated by summing the squares of individual assets’ market shares.
Concentration risk is not limited to Australian and US equities. Fixed income doesn’t avoid the dilemma either, and bond indices are even more concentrated.
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