Residual‐Risk Concentration and the Reliability of Value‐Weighted Portfolio Returns

ABSTRACT Value‐weighted factor portfolios can hold more than a thousand stocks yet remain exposed to firm‐specific risk through only a few. I measure this concentration with residual‐risk breadth , the effective number of firms contributing to return variation unexplained by standard equity factors. Across 70 anomaly portfolios from 1980 to 2024, median breadth falls from 12.7 to 4.0 while the stock count remains above 1000. Weight concentration explains about 41% of the decline; much of the remainder reflects erosion of a historical diversification advantage associated with lower residual variance among larger firms. Recent factor returns are consequently more sensitive to a few companies. A 10% constituent cap raises recent breadth by 81%, reduces the upper tail of residual returns by 14%, and lowers the median within‐predictor alpha standard error by 13% without increasing drift‐adjusted rebalancing turnover. The evidence points to declining reliability of realized value‐weighted factor returns.