Eggs, baskets, and concentration risks

Never put all your eggs in one basket; if you do, watch that basket carefully.
Today’s article covers an increasingly important concept in the face of the collapse of Sliver gate and SVB.
Concentration risk refers to the potential for significant losses arising from an over-reliance on a single asset, group of assets, or industry sector. In other words, it's the risk that comes from having too much exposure to a single factor that could cause a significant impact on an investment portfolio. Concentration risk is not only limited to investments but can also be observed in a company's operations, revenue streams, and customer base.
An example of concentration risk can be observed in what happened last week with the collapse of Slivergate and Silicon Valley Bank (SVB). Both banks had overexposure to the Crypto and Venture Capital industries, respectively, so they began to face challenges when issues arose in these sectors. Suppose a company relies on a single customer (or, in this case, a bank) for most of its revenue. In that case, it could face significant financial difficulties if that customer takes their business elsewhere.
The importance of managing concentration risk cannot be overstated. Diversification is crucial in managing concentration risk. By diversifying an investment portfolio across various asset classes, industries, and geographical locations, investors can spread their risk and reduce the impact of any single loss. Similarly, companies must diversify their operations, revenue streams, and customer base to minimise the effect of a single loss event.
The 2008 financial crisis was partially caused by concentration risk, as many financial institutions had too much exposure to subprime mortgages. The resulting losses had a domino effect on the entire financial system.

To learn

Concentration risk is a significant concern for investors, companies, and regulators. It can severely affect investment portfolios, operations, and the financial system. Managing concentration risk through diversification is crucial for mitigating the impact of potential losses and ensuring long-term financial stability.
On an individual level, this is why you are usually advised to have a mixture of asset classes to ensure your entire financial future is not dependent on a single asset or asset class. On a business level, If you are going to serve a niche market, you must be proactive about insulating yourself from the risk that comes with that industry.

PS: we will release a special article covering SVB’s collapse later this week.