Key takeaways
- Diversification shows how many equally sized positions your portfolio is effectively spread across.
- It takes the weights into account: ten positions, one of which makes up 80%, are hardly diversified in effect.
- The value always lies between 1 and the actual number of your positions.
What does the metric mean?
How widely a portfolio is spread cannot simply be read off the number of positions. If you hold ten securities but put 80% into a single one, you carry almost the risk of a single stock. Talantor expresses the effective number of positions: the number of equally sized positions that would give the same spread.
If all positions are weighted exactly equally, the value matches their number exactly. The more unequal the weights, the further it drops below that. This makes concentration risk visible at once.
An example
Suppose you hold ten securities. If they are all equally weighted (10% each), the effective number is 10. If, on the other hand, a single security makes up 80% and the other nine share the remaining 20%, the value drops to about 1.5 - so despite ten positions, the portfolio is almost as concentrated as a single one.
How Talantor calculates it
The basis is the Herfindahl index, the sum of the squared position weights. Squaring makes large weights count disproportionately. The effective number of positions is the reciprocal of this index. Talantor also shows the actual number of your positions, so you can compare the two directly.
Diversification is more than a position count
Real diversification does not come from many positions alone, but from positions that behave differently. How closely your portfolio as a whole moves with the overall market is shown by beta and correlation.