Holding 30 shares does not mean being diversified. If they are 30 American technology stocks, you are in practice holding a single large position dressed up as thirty.
Reading a correlation
Correlation runs from −1 to +1. At +1, two assets move exactly together (no diversification). At 0, they are independent. At −1, they mirror each other (a perfect hedge, very rare). The diversification benefit appears as soon as correlation falls clearly below +1.
Illusory diversification
- Correlation hidden by sector: two different semiconductor makers are still the same bet.
- Correlation hidden by factor: ten growth stocks fall together when rates rise.
- Correlation hidden by currency or country: a single exposure in disguise.
Correlation is not stable
A correlation computed over five calm years can explode during a shock. In 2008 as in March 2020, almost everything fell together: correlations converged towards 1. You need to know this and not overestimate your protection.
In Earnnest
The portfolio's Risk tab shows a correlation matrix across your main holdings: the most direct way to spot illusory diversification.
À retenir
- ✓The number of lines does not make diversification: low correlation does.
- ✓Beware hidden correlations (sector, factor, currency).
- ✓Correlations rise in a crisis: your protection is weaker than it looks.