The Tysabri bombshell, which hit the markets earlier this week has, not surprisingly, overshadowed all other developments in the Irish financial markets.

Prior to the announcement by Elan and its partner, Biogen, that they were taking Tysabri off the market, Elan's market capitalisation amounted to approximately 10 per cent of the total Iseq market capitalisation. The market's largest stock, AIB, accounts for approximately 16 per cent.

The sudden collapse in the Elan share price knocked 6 per cent off the Iseq index on the day of the announcement and, in one fell swoop, now leaves the Iseq underperforming European indices on a year-to-date basis.

Without Tysabri, analysts estimate that Elan is only worth between $4 (€3) and $5 per share. Until there is some clarity regarding Tysabri's prospects, it is likely that the stock market will attribute little value to it. At best, it is likely that the results of further clinical trials will only be available by the autumn.

Therefore, the prospects for a substantive near-term recovery in Elan's share price are remote.

Fortunately for investors in the Irish market, the fallout from the Elan debacle is unlikely to permeate the rest of the market.

Excluding Elan, the Iseq is still up by 5 per cent year-to-date, which is in line with the return for the FTSE Eurofirst 300 index. Given the specialist focus of Elan in high-risk biotechnology products, investors view it as a "special situation" stock.

Furthermore, the prospects for most Irish companies are bright. For 2004, Kerry Group reported revenue growth of 12 per cent and growth in earnings per share (EPS) of 10.3 per cent. CRH enjoyed sales growth of 16 per cent in 2004 and grew its EPS by 20 per cent.

Whilst the Elan debacle will have little if any negative impact on the rest of the Irish market, it will refocus attention on the long-running debate concerning the stock-specific risk inherent in the Irish equity market.

It is estimated that Irish fund managers hold approximately 20 per cent of their assets in the domestic equity market. Prior to its fall from grace, Elan accounted for 10 per cent of the market, implying that on average, Irish institutional funds would have had close to 2 per cent of total assets invested in Elan.

Therefore, Elan's share price collapse could have knocked as much as 1.5 per cent off the value of Irish pension funds. Of course, many funds may not have held a full market weight in Elan, thus mitigating the negative impact on fund valuations.

It does nevertheless highlight the extent to which Irish pension funds are still exposed to a small number of Irish-quoted companies. Most Irish funds would invest between 2.5 and 3.5 per cent of their total assets in each of AIB, Bank of Ireland and CRH.

This concentration of portfolios in a small number of stocks reflects the small size and concentrated nature of the Irish market.

The top 10 Irish stocks account for almost 80 per cent of total market capitalisation. In the UK market, the equivalent percentage is 40 per cent.

However, high concentration in a few stocks is a common feature of smaller stock markets. For example, the top 10 stocks in the Dutch equity market also account for around 80 per cent of that market's total capitalisation.

Irish institutional investors took advantage of the launch of the euro to achieve portfolio diversification, but they still only hold 20 per cent of their total assets in the domestic market.

There is debate as to whether this weighting should fall further, given that the Irish equity market represents only 2 per cent of total euro zone equities. It is not, however, uncommon for pension funds to invest a high proportion of assets in the domestic market.

UK pension funds have in the region of 50 per cent of their assets invested in UK equities and the equivalent figure for Dutch funds is 40 per cent.

One important factor for Irish pension fund managers is the fact that the Dublin market has consistently outperformed global equities over the past 10 years. With the Irish economy set for a further period of above-average economic growth, the Irish market could continue to outperform a global equity basket.

However, if Irish funds did aggressively rebalance their portfolios away from Irish equities, it would depress the market. Any weakness would probably be short-term, since overseas investors would step in to invest if they perceived that Irish shares had become relatively cheap.

Should private investors also be worried about a high degree of stock-specific risk? The good news is that studies conclude that adequate diversification can be achieved with approximately 15 stocks, carefully selected from across all market sectors.

Elan's collapse highlights the risky nature of equity investment, but it also highlights the need for diversification in the management of all portfolios.