It is very well-known that modern portfolio theory states that diversification is critical to achieve better results at investing. Why? Because the classification of risk goes hand in hand with standard deviation, a statistical measure of a stock's price volatility. However, value investors have spoken against the concept of diversification for a while now. Where are the opinions against modern portfolio theory?
Seth Klarman (Trades, Portfolio), during an MIT conference, said the following:
"My view is that an investor is better off knowing a lot about a few investments than knowing only a little about each of a great many holdings. One’s very best ideas are likely to generate higher returns for a given level of risk than one’s hundredth or thousandth best idea."
“Modern financial theory tells you to calculate the beta of a stock to determine its riskiness. In my entire professional career, now twenty-five years long, I have never calculated a beta. This theory urges you to move your portfolio of holdings closer to the efficient frontier. I have never done so, nor would I know how. I have never calculated the alpha or beta of my firm’s investment performance, which is how some people would determine whether or not we have done a good job.”
“Some people stick to elegant theories long after it is apparent that the theories do not explain reality. The Chicago School of Economics has said the financial markets are efficient. They conveniently explain away Warren Buffett (Trades, Portfolio)’s incredible investment record as aberrational. The second richest man in the country is a value investor; he built his net worth gradually over nearly 50 years of successful investing. And his net worth continues to grow handsomely! Fifty billion dollars are a lot of aberrations! Rather than abandon their theorizing to study Buffett exhaustively to see what lessons could be learned, too many people cannot bear to re-examine their faulty theories.”
I was impressed to read these very direct comments towards MPT. It is true that some academics have tried to disregard Warren Buffett (Trades, Portfolio)'s success by classifying him as an aberration or simply a statistical error. However, as he discussed handsomely in "The Superinvestors of Graham and Doddsville," it is unlikely that an investment philosophy used by several investors is able to repeatedly beat the market works with these results being a statistical anomaly.
Buffett wrote the following in his article: "Our Graham & Dodd investors, needless to say, do not discuss beta, the capital asset pricing model, or covariance in returns among securities. These are not subjects of any interest to them. In fact, most of them would have difficulty defining those terms. The investors simply focus on two variables: price and value."
This, I believe, is the proof that while market efficiency exists, it exists in its weak form, with certain time lags particularly in lower capitalization stocks. If market efficiency was inexistent, then bargains would remain that way, not allowing value investors to reap the profits as stocks reflect their fundamental value. Now, value investors do diversify across sectors, but they do so based on their readings of the underlying economics, not on statisfical measures such as beta or standard deviations.
As Buffett mentions, value investors are only focused on two things  — price and value  — and try to bet heavily when they find the biggest discrepancies between the two.
