Focused investments illuminating growth in a portfolio, surreal illustration.

Unlock Your Investing Potential: Is a Concentrated Portfolio the Key to Outsized Returns?

Beau Callahan in Business & Economy December 2025 • 4 min read.

"Discover how focusing on a few high-conviction investments, backed by robust fundamentals, can potentially outperform the risks of diversification, according to insights from top investors and mathematical models."

For years, the conventional wisdom in investing has leaned heavily towards diversification—spreading your capital across a wide range of assets to mitigate risk. However, a growing chorus of voices, including legendary investors like Warren Buffett and Charlie Munger, champions a different approach: focused investing. This strategy involves concentrating your investments in a smaller number of carefully selected companies, where you have a high degree of conviction and understanding.

The core idea behind focused investing is that not all investment opportunities are created equal. By dedicating your time and resources to thoroughly analyzing a select few businesses, you can develop a deeper understanding of their intrinsic value and long-term potential. This, in turn, allows you to make more informed investment decisions and potentially achieve outsized returns.

But how do you determine the optimal allocation of capital in a focused portfolio? It's a question that has captivated investors and researchers alike. A recent research paper provides a mathematical model and tool designed to help investors navigate this challenge, combining fundamental analysis with a structured approach to risk management and capital allocation.

The Power of Focused Investing: A Deep Dive

Focused investments illuminating growth in a portfolio, surreal illustration.

A recent study introduces a mathematical model designed to optimize capital allocation within a focused investment strategy. This model, rooted in the principles of investors like Buffett and Munger, emphasizes the importance of understanding the probabilities of different outcomes for a select group of businesses. By quantifying these probabilities and the potential returns, the model aims to guide investors toward an optimal allocation of capital for each investment candidate.

At its heart, the model is based on a generalized Kelly Criterion, a formula used to determine the optimal size of a series of bets to maximize long-term growth. In the context of investing, this translates to determining how much of your capital to allocate to each company in your focused portfolio. However, the model goes beyond the basic Kelly Criterion by incorporating constraints that reflect real-world considerations and investor preferences. These constraints include:

No Shorting: Prevents taking short positions, aligning with a long-term, value-oriented approach.
Limited Leverage: Restricts the use of borrowed capital to manage risk and maintain a conservative financial profile.
Maximum Loss Limit: Sets a limit on the potential permanent loss of capital, safeguarding against catastrophic outcomes.
Individual Allocation Cap: Limits the maximum allocation to any single investment, preventing over-concentration in a single company.

These constraints are designed to mitigate risk and ensure that the portfolio aligns with the investor's risk tolerance and investment goals. By incorporating these safeguards, the model aims to provide a more practical and realistic framework for focused investing.

The Future of Focused Investing: A Call to Prudent Action

While the mathematical model offers a valuable tool for optimizing capital allocation, the ultimate success of focused investing hinges on the investor's ability to conduct thorough fundamental analysis and develop a deep understanding of the businesses in their portfolio. This requires a commitment to continuous learning, critical thinking, and a willingness to challenge conventional wisdom. By combining a disciplined approach to fundamental analysis with a structured framework for risk management, investors can potentially unlock the power of focused investing and achieve outsized returns.

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This article is based on research published under:

DOI-LINK: https://doi.org/10.48550/arXiv.2402.15588,

Title: Sizing The Bets In A Focused Portfolio

Subject: q-fin.pm q-fin.cp

Authors: Vuko Vukcevic, Robert Keser

Published: 23-02-2024

Everything You Need To Know

What is focused investing, and how does it differ from traditional diversification?

Focused investing is an investment strategy where capital is concentrated in a smaller number of carefully selected companies based on a high degree of conviction and understanding. It contrasts with traditional diversification, which spreads capital across a wide range of assets to mitigate risk. The belief behind focused investing is that deep analysis of a few businesses can lead to a better understanding of their intrinsic value and potentially higher returns compared to spreading investments thinly across numerous, less-understood assets. Investors like Warren Buffett and Charlie Munger advocate for this approach, emphasizing the importance of thorough understanding over broad diversification.

How can a mathematical model assist in optimizing capital allocation within a focused investment strategy?

A mathematical model, particularly one based on a generalized Kelly Criterion, can guide investors in determining the optimal allocation of capital within a focused portfolio. This model quantifies the probabilities of different outcomes for a select group of businesses and their potential returns. By incorporating constraints like 'No Shorting,' 'Limited Leverage,' 'Maximum Loss Limit,' and 'Individual Allocation Cap,' the model provides a structured approach to risk management and helps align capital allocation with the investor's risk tolerance and investment goals. Such a model aims to balance potential gains with acceptable levels of risk, leading to more informed investment decisions.

What are the key constraints incorporated into the mathematical model for focused investing, and why are they important?

The mathematical model includes several key constraints designed to mitigate risk and align with a long-term, value-oriented approach. These constraints are: 1. 'No Shorting': Prevents taking short positions, focusing on long-term growth. 2. 'Limited Leverage': Restricts the use of borrowed capital to manage risk. 3. 'Maximum Loss Limit': Sets a limit on the potential permanent loss of capital, safeguarding against catastrophic outcomes. 4. 'Individual Allocation Cap': Limits the maximum allocation to any single investment, preventing over-concentration.These constraints are important because they provide a more practical and realistic framework for focused investing, ensuring that the portfolio remains aligned with the investor's risk tolerance and investment goals while preventing excessive risk-taking.

What role does fundamental analysis play in the success of a focused investment strategy, even with the use of a mathematical model?

While a mathematical model offers a valuable tool for optimizing capital allocation, the ultimate success of focused investing relies heavily on the investor's ability to conduct thorough fundamental analysis. This involves developing a deep understanding of the businesses in the portfolio through continuous learning, critical thinking, and challenging conventional wisdom. The model serves as a guide, but the investor's insight into the intrinsic value, competitive advantages, and long-term potential of the companies is crucial for making informed decisions. Fundamental analysis helps refine the probabilities and potential returns used within the model, making it more accurate and effective.

What are the potential benefits and drawbacks of using the Kelly Criterion as a foundation for capital allocation in focused investing, and how does the generalized model address these?

The Kelly Criterion is a formula used to determine the optimal size of a series of bets to maximize long-term growth. In focused investing, it translates to determining how much capital to allocate to each company. A potential benefit is its focus on maximizing growth based on probabilities and potential returns. However, a drawback is that the basic Kelly Criterion can sometimes recommend very aggressive allocations, which may not be suitable for all investors or real-world market conditions. The generalized model addresses this by incorporating constraints such as 'No Shorting', 'Limited Leverage', 'Maximum Loss Limit', and 'Individual Allocation Cap.' These constraints help to temper the aggressiveness of the Kelly Criterion, making it more practical and aligned with an investor's risk tolerance and investment goals, thus mitigating potential downsides while still leveraging its growth-maximizing potential.