Diversification
Diversification is spreading exposure across different assets, managers, sectors, or strategies to reduce dependence on any single outcome.
Allocator relevance: A foundational risk management principle that improves portfolio resilience—when exposures are truly uncorrelated.
Expanded Definition
Diversification works when exposures respond differently to economic regimes. Superficial diversification (different managers with the same factor and sector exposure) can create false comfort. In private markets, diversification must account for liquidity, vintage year dispersion, and look-through overlap across underlying holdings.
Effective diversification is deliberate: it is designed to manage drawdowns and maintain liquidity under stress.
How It Works in Practice
Allocators diversify across asset classes, strategies, geographies, and managers, then validate overlap through look-through exposure, correlation, and scenario analysis. They also manage diversification over time through pacing and rebalancing.
Decision Authority and Governance
Risk budgets and portfolio construction frameworks define diversification targets and concentration limits. Governance ensures drift is identified and corrected, especially after market moves.
Common Misconceptions
- More positions always mean more diversification.
- Diversification eliminates drawdowns.
- Private market diversification is automatic.
Key Takeaways
- Diversification depends on correlation, not labels.
- Look-through exposure is essential.
- Liquidity constraints make diversification planning more important.