Where does diversification collide?

The practice of holding a variety of assets whose returns do not move perfectly together, so that the ups and downs partly cancel and the whole portfolio carries less risk than its pieces would suggest. Markowitz's 1952 Portfolio Selection in the Journal of Finance showed mathematically that risk depends on how assets covary, not just on each asset alone, so combining imperfectly correlated holdings can lower variance without lowering expected return, an effect later called the only free lunch in investing. The referent is a statistical property of a bundle of holdings, measured by variance and correlation, and it is not a firm entering new markets, the branching of life into new species, or a country spreading its economy across sectors.[1]

Unit

One investor's portfolio, scored by its return variance and asset correlations

Recovery means

Not applicable

Measured by

Quantified by portfolio variance, the covariance or correlation matrix of returns, and effective number of holdings

The growth of a single firm into new products, industries, or markets beyond its original line of business, whether closely related to what it already does or unrelated to it. Montgomery's 1994 Corporate Diversification in the Journal of Economic Perspectives reviewed why firms broaden their scope and the recurring finding of a diversification discount, where a company spanning many unrelated businesses is often valued below the sum of comparable standalone firms. The referent is a choice about the boundaries of one company, described by how many and how related its businesses are, and it is not the risk in an investor's portfolio, the branching of species over time, or the sector mix of a national economy.[2]

Unit

One firm, classed by the number and relatedness of the businesses it spans

Recovery means

Not applicable

Measured by

Captured by counts of business segments, relatedness categories, entropy indices, and valuation ratios such as Tobin's q

In macroevolution, the net build-up of the number of species in a group over time, understood as the balance between the rate at which new species arise and the rate at which existing ones go extinct. Nee's 2006 Birth-Death Models in Macroevolution in the Annual Review of Ecology, Evolution, and Systematics set out how the shape of a phylogenetic tree lets biologists estimate these speciation and extinction rates and the diversification rate that is their difference. The referent is a property of a lineage measured across deep time, counted in species and rates per lineage per million years, and it has nothing to do with an investor's holdings, a company's range of businesses, or a country's economic sectors.[3]

Unit

A clade, scored by its net rate of species gain per lineage over time

Recovery means

Not applicable

Measured by

Estimated from fossil counts and from birth-death models fitted to dated phylogenetic trees

The spreading of a whole economy's activity across many sectors, crops, or export products, rather than concentrating it in a few, which is meant to reduce a country's vulnerability to a shock in any one of them. Imbs and Wacziarg's 2003 Stages of Diversification in the American Economic Review found that as poor countries grow richer their production first spreads out across sectors and only re-concentrates at high income, a U-shaped path. The referent is the composition of a nation's output or exports, measured by how evenly activity is distributed across categories, and it is not the risk in a portfolio, one firm's range of businesses, or the branching of life into species.[4]

Unit

A country's output or export basket, scored by how evenly it spreads across categories

Recovery means

Not applicable

Measured by

Gauged by sectoral concentration indices such as Gini or Herfindahl measures over employment, output, or exports