Diversification
Holding things that do not move together, so their independent disappointments cancel. It lowers risk without lowering expected return, which nothing else does.
Where you will meet it
Diversification appears in 35 learning outcomes on the CFA syllabus. A few of them:
- Work out the expected return on a portfolio of two assets
“That gap is the diversification benefit, and it is the reason risk must be assessed at portfolio level rather than asset by asset.”
- Contrast REITs with owning property directly
“A REIT gives daily liquidity, professional management, diversification across many properties and a small minimum investment, at the cost of market-price volatility that often tracks equities more closely than property values do.”
- Explain geopolitical risk and how it bears on investments
“It is characteristically hard to price: the probabilities are hard to estimate from history, the outcomes are discontinuous, and correlations that held in calm periods break precisely when diversification is most wanted.”
- Explain the main ratios and other considerations used when analysing an insurer
“Life and health insurers are judged on product diversification, earnings from benefits and expenses relative to premiums and deposits, investment returns and portfolio quality, liquidity and risk-based capital.”
Practise it
Practise diversification until it is automatic: questions that explain every wrong option.
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