Diversification and correlation
Independence of risk drivers — not the number of holdings.
Diversification and correlation
| Concept | Explanation | |---|---| | Diversification | Spreading exposure across different sources of return and risk. | | Correlation | Historical relationship between asset returns. | | Common factor | Underlying driver shared by several holdings. | | Correlation regime | Period in which relationships strengthen or weaken. | | Diversification benefit | Reduction in portfolio variability from imperfectly correlated assets. |
Key idea: The number of holdings is not the measure of diversification. The independence of their risk drivers is.