Naive diversification

Naive diversification

A strategy whereby an investor simply invests in a number of different assets in the hope that the variance of the expected return on the portfolio is lowered. In contrast, mathematical programming can be used to select the best possible investment weights. Related: Markowitz diversification.

Naive Diversification

Diversification of a portfolio without regard, or with incorrect regard, for the mathematical formulas in the capital asset pricing model. Naive diversification rests on the assumption that simply investing in enough unrelated assets will reduce risk sufficiently to make a profit. Alternately, one may diversify naively by applying the capital asset pricing model incorrectly and finding the wrong efficient portfolio frontier. Such diversification does not necessarily decrease risk at a given expected return, and may in fact increase risk. See also: Markowitz Portfolio Theory.
References in periodicals archive ?
Naive diversification requires periodic reassessments of which stocks and other assets to include in a portfolio.
Naive diversification works well for large portfolios but often backfires when applied to a few assets, says Richard Thaler of the University of Chicago, a leading behavioral economist and critic of Gigerenzer's approach.
These are (i) naive diversification which is based purely on a subjective estimate of portfolio's benefits and (ii) MPT based quantitative techniques such as mean-variance analysis, constant correlation analysis and single index model.
As shown in Table 1, all of the institutional property investors adopted naive diversification strategies in their practices.
1%) of the practitioners were adopting naive diversification strategies.
This might have influenced respondents' decisions towards naive diversification strategies since the methods require little or no pre-requisite knowledge before they could be used.
78%) of the 9 Higher National Diploma certificate holders used naive diversification strategies.
A strategy of investing that does not take into account the correlation coefficients is considered to be naive diversification.
It also opens the possibility that an efficient portfolio developed by using constant correlation analysis may not be more efficient than a naively diversified portfolio as some of the naive diversification strategies are found to be effectively efficient.
KEYWORDS: Evaluation; Managers diversification; Real estate portfolio; Constant correlation model; Naive diversification
Following from the procedures described above, optimal portfolios are constructed and their efficiency compared with the various naive portfolios developed so as to determine the superiority or otherwise of the naive diversification schemes.
In all, 18 different naive diversification portfolios were considered and their mean/standard deviation ratio as well as effectiveness of diversification compared with the efficient portfolios.