Portfolio Diversification: Understanding Risk
Diversification takes more than owning many products. Explore how asset classes, risk drivers and correlations influence the structure of a portfolio.
Diversification is often confused with holding a large number of positions. What matters, however, is which risk drivers actually move a portfolio: interest rates, the economic cycle, creditworthiness, currencies, liquidity. Ten products with the same risk driver are not diversification, but repetition.
Look at risk drivers rather than product count
True diversification begins with structure: asset classes, regions, maturities and degrees of liquidity are deliberately combined so that different building blocks carry the portfolio through different market phases. The aim is not to maximise returns in a single scenario, but to remain resilient across many.
Correlations can change, especially in stressed markets. Portfolio analysis should therefore include adverse scenarios: what happens when rates rise, the economy weakens or market liquidity falls? The answer may matter more than the number of holdings.
