As an independent RIA, one of our core responsibilities is making sure that when we compare performance, it is done accurately, fairly, and in a way that truly reflects the value we add. Performance numbers only mean something if they’re compared to the right benchmark, so the benchmark must be structured in a way that mirrors how your portfolio is actually invested.
One important, but often overlooked, part of that process is portfolio concentration. Concentration simply refers to outsized weight being placed in a small number of holdings versus being spread evenly across many investments. In other words, having ostrich eggs and quail eggs in the same basket.
Concentration affects both risk and return. More concentrated portfolios can outperform dramatically when their largest holdings do well - but they can also underperform just as dramatically if those positions struggle. Less concentrated portfolios tend to have more moderate, diversified outcomes. Because concentration directly impacts potential returns, it must be considered when comparing performance.
Many investment firms compare their portfolios to broad market indexes, like the S&P 500, NASDAQ-100, Russell, or global benchmarks. These are useful tools, but they are not all structured the same way. Some are more concentrated than others and, in certain years, just a handful of very large companies can drive most of an index’s return. We’ve seen this recently in the “Magnificent 7” stocks like Apple, Google, and Microsoft. Their magnificent run has led to their being dramatically overconcentrated in all major indexes, reducing those indices’ value to us as benchmarks.
If a benchmark is heavily concentrated but your portfolio is more balanced, or vice versa, the comparison to broad indexes can become distorted. You may appear to be underperforming or outperforming simply because the concentration levels differ, not because of the quality of investment decisions. That would not be a fair comparison for us or for you.
To solve this problem, we use a measurement called the Herfindahl-Hirschmann Index (HHI). The idea is straightforward: the HHI measures how concentrated a portfolio or index is, and we use this number to compare our models and their accurate benchmarks.
We calculate the concentration level of our portfolio models and compare them to the concentration level of the benchmark we use for performance reporting. If needed, we adjust the benchmark components so that the level of concentration is aligned with our model.
In simple terms: When reporting performance to you, we make sure we are comparing apples to apples.
This approach matters to you in several important ways:
1. It Prevents Misleading Comparisons
If an index is driven by just a few large companies but your portfolio is intentionally diversified, comparing the two without adjusting for concentration would not reflect the actual investment strategy you’re paying for. By aligning concentration levels, we remove structural bias from the comparison.
2. It Compares Us to What You Could Realistically Do on Your Own
You could simply purchase a low-cost index fund that tracks a broad benchmark like the S&P 500. But doing so would expose you to the previously mentioned concentration risk that we invest to reduce. So, when we report performance, we measure ourselves against a benchmark that reflects a similar level of concentration. That way, we can clearly evaluate whether our models are delivering value relative to what you could do yourself.
3. It Improves Risk Transparency
Concentration is directly tied to volatility risk. When a benchmark becomes more concentrated - which happens frequently in U.S. markets - its volatility profile intensifies with both higher highs and lower lows. If concentration is not accounted for, performance comparisons can unintentionally hide the true risk taken to achieve returns. By monitoring and aligning concentration, we ensure that risk levels are comparable, performance differences are meaningful, and reporting remains transparent.
The Bottom Line
Markets evolve. Indexes change. Concentration levels shift continuously. Our responsibility is not just to manage your investments, but also to ensure that how we measure our results is thoughtful, accurate, and transparent. Using HHI to align our portfolio and benchmark concentrations is one of the ways we uphold that responsibility. Clear explanations build confidence and trust, and those are the building blocks of our ability to Put You At Ease.