Not true.
Naive diversification is combining assets into portfolios randomly and ignore correlation. In contrast, Markowitz diversification is combining assets with correlation coefficients.
Naive diversification basically refers to having a portfolio strategy of 1/N as weights to each asset where N=no of assets, without taking into consideration the degree of covariance or correlation between pair of stocks.
Naive diversification rest on the assumption that simply investing in enough unrelated assets will reduce risk sufficiently to make a profit. Alternatively, one may diversify naively by applying the capital asset pricing model incorrectly and finding the wrong efficient portfolio frontier. Such diversification does not necessary decrease risk at a given expected return and may in fact increase risk.
Markowitz diversification occurs when one uses mathematical models to find the stock to place in portfolio such that the portfolio has the highest possible return for its level of risk. One may engage in MArkowitz diversification when one wishes to increases or decreases one's portfolio's risk, or when the portfolio was previously not diversified.
Naive 1/N equally-weighted strategy is about buying under-performing assets and selling outperforming ones when rebalancing the portfolio.
BR
Investor can be naive if he/she operates in an efficient market but can't be naive in no efficient market. In efficient market alpha will be close to zero and at that time it does not matter to invest 1/N in each security of choice but in no efficient market abnormal return is possible and the 1/N won't form the best return portfolio.
The problem with MPT is the presupposition that somehow, the correlation between assets" returns is less than unity, and ideally negatively correlated. This is a naive assumption in itself, as the global financial crisis taught us. The actual naive strategy does not make such an assumption....it simply advocates the avoidance of putting all eggs in one basket so that they do not get crushed. This is where you realize the two converge...
- Badges
- Science topic