Factor Performance vs Portfolio Concentration

The more concentrated, the higher the returns, right?

December 2025. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • More concentrated portfolios generated higher excess returns for value & momentum stocks
  • In contrast, higher diversification was beneficial for other factors like quality and growth
  • It is difficult to explain this, but has consequences for multi-factor portfolio construction

INTRODUCTION

Factor investing appears to be the only strategy for outperforming the market over the medium to long term. Intuitively, the more concentrated a portfolio, the greater the potential for outperformance. This idea has been reflected in recent years by the launch of several smart beta ETFs with highly concentrated holdings – for example, the John Hancock Disciplined Value Select ETF (JDVL) holds just 40 stocks.

On the other hand, some funds take a much more diversified approach. The DFA Dimensional US Targeted Value ETF (DFAT), for instance, includes nearly 1,500 stocks – roughly half of the U.S. equity market.

The trade-off is clear: extreme concentration introduces firm-specific risk, while excessive diversification can dilute factor exposures. So, where does the sweet spot lie? And do more concentrated portfolios consistently deliver superior performance across all factors? Let’s dive in.

FACTOR PERFORMANCE VS PORTFOLIO CONCENTRATION

We focus on the U.S. stock market and construct six portfolios based on standard factor definitions: momentum, value, growth, low volatility, quality, and market capitalization. Stocks are weighted equally, portfolios are rebalanced monthly, with 10 basis points of transaction costs deducted, and only stocks with a minimum market capitalization of $1 billion are included in the investible universe.

For each factor, we create portfolios selecting the top 2%, 5%, 10%, 20%, and 30% of stocks. The top 2% stock portfolio was comprised of 25 stocks in 2005 and 43 stocks in 2025, compared to 376 respectively 643 stocks for the top 30% portfolio. Then we subtract overall market returns to calculate factor excess returns.

Between 2005 and 2025, we find that positive factor excess returns occurred only for value and momentum, consistent with academic research. Interestingly, the excess returns for these two factors increased with p