Portfolio Diversification Strategies Flashcards
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Read the first 7 Portfolio Diversification Strategies flashcards as text
Which diversification strategy involves spreading investments across different points in time to reduce timing risk?
Answer: Dollar-cost averaging
Dollar-cost averaging reduces timing risk by investing fixed amounts at regular intervals, buying more shares when prices are low and fewer when prices are high.
Which asset class historically has the lowest correlation with U.S. large-cap equities, providing the greatest diversification benefit?
Answer: Commodities
Commodities tend to have low or negative correlation with equities, especially during inflationary periods when stocks struggle.
A portfolio has a correlation of -1 between its two assets. What happens to portfolio variance as weight shifts between them?
Answer: Portfolio variance can theoretically be reduced to zero at the optimal weighting
With perfect negative correlation, there exists a specific weighting combination at which the two assets' movements completely offset each other, yielding zero portfolio variance.
An investor uses a 'core-satellite' approach. The core allocation typically consists of:
Answer: Broad, low-cost, passively managed index funds providing market exposure
In a core-satellite portfolio, the core is a diversified, low-cost passive base, while satellites are active or alternative positions seeking alpha.
What does 'geographic diversification' primarily protect against?
Answer: Country-specific economic downturns, political instability, and regulatory changes
Geographic diversification reduces the impact of adverse events in any single country, such as recession, political upheaval, or abrupt regulatory shifts.
Which measure captures the portion of portfolio risk that cannot be eliminated through diversification?
Answer: Systematic risk
Systematic (market) risk affects all assets broadly and cannot be diversified away, unlike idiosyncratic risk which is security-specific.
A trader notices that during the 2020 COVID crash, almost all asset classes fell simultaneously. This phenomenon is known as:
Answer: Correlation convergence (or contagion)
During extreme market stress, correlations between asset classes tend to spike toward 1 as panic selling affects all markets simultaneously, reducing diversification benefits.