By Saiful Bahri Kamaruddin
Pix Abd Ra’ai Osman

BANGI, 6 November 2015 – A renowned Professor of Finance said contrary to popular belief, diversifying investments in the financial markets do not necessarily reduce risks.

The fundamental problem is that forecast returns did not yield the expected results because risk had been measured the wrong way,  said Prof Ben Jacobsen, holder of the Tun Ismail Mohamed Ali Foundation-UKM Endowment Chair at the Faculty of Economics and Management, National University of Malaysia (UKM).

Prof Jacobsen said you could invest all you have in a fewer companies instead of spreading your money out if you are really confident about the information you have about the firms.

“I am no longer a believer in diversification as the sole optimal strategy. I think this strongly depends on how you perceive risk and whether you feel you understand the assets and companies you invest in.

“If you feel you have better information or can better assess the value of information about specific sectors or companies, I think there is nothing wrong with a highly concentrated portfolio,” said Prof Jacobsen at his public lecture titled The Shaking Foundations of Finance, here today.

He expressed fear that the shortcomings he observed might just result in the financial markets crashing again one day.

“I remember the economic downturn in developed countries in 2008. No one saw it coming nor predicted the stock market collapse and bankruptcy of many companies,” he stressed.

One of the problems, he reasoned, is that there is too little innovation despite there being a lot of data.

“I have a feeling why this may be happening. In my experience, compared to other sciences main stream academic finance tends to be more risk averse and conservative.

“Researchers have a tendency to stay close to the main stream because there is a general feeling out there that the risk-return relation also may not hold in this area.

“No matter  how solid your research it should not deviate too much from conventional thinking. Because the feeling is that high risk in academic finance research does not lead to high returns (top publications).

“The focus on getting published rather than the progress of science also leads to an absence of debate. As a result –‐ for safety and not to miss out on a publication –‐ finance academics often stick to the conventions even if they feel these might be questionable,” he explained.

According to him,  people who openly question mainstream research – unless they are well established – are often ignored.

However, the irony is that too much data, or Data Mining,  can also lead to errors in judgement because of the over-reliance of statistics.

“When you have many researchers all over the world testing for significant effects, many may find spurious effects. As we (and journals) tend to be biased towards reporting significant effects and ignoring the insignificant ones, this makes it very hard to distinguish whether the published effects are truly there or not, particularly because in economics and finance it is relatively easy to support claims with one theory or another. While there are safeguards, recently some researchers are wondering whether these are safeguarding enough,” he elaborated.

However, he said he is still positive about the outlook of forecasting the financial markets.

He said the stock markets can still be predictable if  if researchers and investors use different kinds of index trackers although they may not be right all the time.

“That does not mean that my decisions are always right but they tend to be more  56 often than not. I am not looking at diversification per se but more on hedging  risks as I perceive them, “ he added.

Prof Jacobsen holds the Tun Ismail Mohamed Ali Distinguished Chair at the Faculty of Economics and Management, UKM . He will join the TIAS Business School at the University of Tilburg in the Netherlands as a Professor in Finance in January 2016. His research focuses on forecasting financial markets and behavioural finance.