Is the diversified portfolio dead? The AI boom has turned an age-old investing rule on its head.

With the rise of AI superstocks, the U.S. equities market has rarely been so concentrated. Those stocks’ explosive gains have raised concerns that investors may be putting too many of their eggs in one basket.

But the wild success of a handful of AI-related names has also rekindled an old debate within investing circles about how well a diversified portfolio even works.

Modern portfolio theory shows investors derive a number of benefits from owning a diversified portfolio consisting of a large number of stocks, coupled with risk-free Treasury bonds. Chief among them, according to the pioneering research of Harry Markowitz, is that they can reap similar returns with lower levels of volatility. For decades, diversification has been considered the only “free lunch” available to most investors; Markowitz, a University of Chicago economist, was awarded the Nobel Prize in Economic Sciences for this work.

But as the U.S. stock market becomes increasingly divided between winners and losers, some are questioning whether owning a broadly diversified portfolio of equities still makes sense. Professional managers might be able to produce better outcomes for their clients by owning a concentrated portfolio of between 10 and 30 positions, according to a paper published in 2017 by Alpha Theory, a software platform for investment managers.

Since the U.S. equities market emerged from a brief but painful bear market in late 2022, the ideas expressed in the Alpha Theory manifesto have re-entered the conversation in the investment-management business. Returns for indexes like the S&P 500 SPX and Nasdaq Composite COMP have been disproportionately powered by a small number of megacap stocks mostly in the technology sector, as the artificial-intelligence boom has transformed the investing landscape.

Brian Chingono, director of quantitative research at Verdad Advisers, addressed the debate in research shared with MarketWatch last week. He told MarketWatch he was inspired to dig deeper after several conversations with investors and capital allocators — the individuals who dole out money to investment managers on behalf of pension funds, endowments and other large pools of capital.

“We had noticed there was a preference toward more concentrated portfolios, which obviously is in contrast to what is typically taught in finance courses,” Chingono told MarketWatch.

It is no secret that, over the past few years, the weighting of the S&P 500 has become more lopsided toward the biggest stocks.

Michael Kantrowitz, chief investment strategist and head of portfolio strategy at Piper Sandler, recently said that the large-cap index is more concentrated than it has been at any time over the past 100 years. Equity strategists at Goldman Sachs recently found that the 10 largest stocks in the S&P 500 account for roughly 40% of the index’s value. This could potentially create problems for investors who entrust their money to index funds like the SPDR S&P 500 ETF SPY or the Vanguard S&P 500 ETF VOO.

Alpha Theory founder Cameron Hight, who authored the 2017 paper, isn’t alone in questioning the merits of diversification.

Over the years, a number of legendary investors have expressed doubts of their own. In his 1993 letter to shareholders, Berkshire Hathaway Inc.’s BRK.A BRK.B Warren Buffett said that his firm didn’t adhere to “standard diversification dogma.” Contrary to the accepted wisdom, a more concentrated portfolio could actually decrease risk by requiring the portfolio manager to better understand the economic characteristics of their investments, Buffett noted.

However, a few paragraphs later, Buffett clarified that this approach was strictly for professionals. Investors who lack a sophisticated understanding of American industry would be better off sticking with an index fund.

A representative for Buffett confirmed that the views of the “Oracle of Omaha” regarding diversification haven’t changed. The representative also pointed out that Charlie Munger, who served as Berkshire’s vice chairman until he passed away in late 2023, had an even more extreme take: Munger believed that a professional investor should own no more than three stocks at a time, the Berkshire representative said.

Peter Lynch, former manager of Fidelity’s legendary mutual fund, the Magellan Fund FMAGX, has been credited with coining the phrase “di-worsification” to poke fun at what he saw as needlessly overcomplicated portfolios. During a lecture given in 1997, Lynch said that he would be happy owning even a single stock in his portfolio.

Alpha Theory’s Hight wasn’t available to comment when contacted by MarketWatch. A representative for Lynch’s foundation also said he wasn’t available for comment.

Hight at Alpha Theory said in his 2017 report that he had initially penned his concentration manifesto to address a challenge facing his firm’s clients.

Over time, the number of large-cap funds that outperform the S&P 500 has been small. According to the latest analysis from S&P Dow Jones Indices, about 95% of actively managed large-capitalization U.S. equity funds have underperformed the popular benchmark over the past decade, after factoring in fees.

Hight started by taking a close look at his clients’ portfolios, according to the report. At first, what he found was discouraging: Only 51% of positions turned a profit. Despite this, many were ultimately able to deliver positive investment returns because they reliably allocated more capital to their winning positions than their losing ones.

Hight concluded that sophisticated investors tended to allocate more capital to their most promising ideas. As markets have grown more competitive over time, compelling opportunities have become increasingly hard to come by. Since high-conviction ideas tend to generate better performance, why shouldn’t managers limit their portfolios to between 10 and 30 such bets?

This approach would enable managers to devote more time to better understanding the characteristics of their chosen investments. Capital allocators, meanwhile, could still achieve many of the benefits of diversification by doling out capital to a host of different managers.

Hight also found that positions exhibiting “crowding” have tended to outperform over time. He cited the long-term outperformance of Goldman Sachs’s Hedge Fund VIP Index as evidence that hedge-fund managers are, in fact, gifted stock pickers.

There might be something to this. An ETF launched in late 2016 to track the Goldman Sachs index has indeed bested the S&P 500 since its launch. The Goldman Sachs Hedge Industry VIP ETF GVIP has appreciated by 293.26% since Nov. 3, 2016, according to Dow Jones Market Data; the S&P 500 has risen by 220.4% over the same period. The ETF includes the 50 U.S. stocks that most frequently appear in top holdings of hedge funds.

Others pushed back on Alpha Theory’s findings. Verdad’s Chingono simulated the 10-year performance of tens of thousands of portfolios, with holdings ranging from five stocks to 500, using U.S. stock-market performance data from 1996 to 2023.

He found that the median compounded return for hyperconcentrated funds was lower than the median return for their more diversified peers. Furthermore, some 40% of concentrated funds in the simulation delivered annualized returns of less than 5% over a decade.

Chingono’s study may have relied on simulated performance, but in his report, he referenced an earlier academic study which examined the returns of real mutual funds. It arrived at a similar conclusion.

The Alpha Theory report offers the most compelling argument for running a more concentrated portfolio, Chingono said. But the firm’s analysis is flawed in one important respect: It ignores the impact of survivorship bias, something that Hight himself acknowledged in the report.

“Once you can see the full distribution of outcomes, it becomes very clear that it is in investor’s best interest to be diversified, as opposed to hyperconcentrated,” Chingono told MarketWatch.

Acadian Asset Management portfolio manager Owen Lamont delivered a more forceful rebuttal in a report he authored back in March. That the top-performing hedge funds of 2024 seemed to all embrace concentration doesn’t vindicate this approach; instead, it simply means that volatility for these funds is higher than it would be for investors who run diversified portfolios.

“You’d expect to find concentrated funds at either the top or the bottom of any list ranked by performance. Indeed, the top fund of 2024 was down 77% in 2022,” Lamont said in his report. Furthermore, the idea that concentrated portfolios are actually less risky is “just bonkers, totally untrue and inconsistent with both evidence and theory.”

Lamont also questioned the notion that betting on a few high-conviction ideas can generate meaningful outperformance. This suggests that investment professionals can reliably anticipate the future, he said. But history has shown that this is exceedingly difficult in practice.

The Acadian portfolio manager rattled off a list of lauded equity managers who have underperformed the S&P 500 while running a more concentrated portfolio. One notable example has been ARK Investment Management’s Cathie Wood: Wood’s ARK Innovation ETF ARKK has fallen by more than 46% since its peak in February 2021, according to Dow Jones Market Data — although the fund has gained nearly 50% since the start of 2025.