Herfindahl-Hirschman Index

A metric used to measure market concentration or portfolio concentration by summing the squared weights of individual constituents.

The Herfindahl-Hirschman Index (HHI) is a mathematical metric used to measure concentration within a specific system. In economics and antitrust regulation, it is used to assess market competitiveness and identify monopolistic industries. In investing, portfolio managers and retail investors use it to evaluate the true diversification of a portfolio or fund. To calculate the HHI, you square the percentage weight of each individual constituent in a group and then sum those squared values. By squaring the weights, the index assigns disproportionately higher importance to larger holdings. The index ranges from close to 0, representing a perfectly competitive market or an infinitely diversified portfolio, to 10,000, which represents a absolute monopoly or a portfolio concentrated entirely in a single asset. For investors, calculating the HHI reveals concentration risks that simple holding counts might hide. For example, an exchange-traded fund might hold 500 stocks, suggesting excellent diversification. However, if the top five mega-cap stocks command the vast majority of the fund's total weight, the HHI will be high. This alerts the investor that the fund's performance is highly dependent on just a few companies, exposing them to unexpected systemic or stock-specific shocks. In general, an HHI below 1,500 indicates a highly diversified portfolio or a highly competitive market. An HHI between 1,500 and 2,500 signals moderate concentration, while any score above 2,500 indicates high concentration. Investors should monitor this metric to ensure their asset allocation aligns with their actual risk tolerance.

An investor holds a portfolio with four stocks weighted at 40%, 30%, 20%, and 10%. To find the Herfindahl-Hirschman Index, square each percentage weight and add them together: (40^2) + (30^2) + (20^2) + (10^2) = 1,600 + 900 + 400 + 100 = 3,000. An HHI of 3,000 indicates a highly concentrated portfolio.