Diversification involves allocating capital spread across many securities as protection against the risk of being wrong, while also maximizing the potential of being right. Being wrong or the risk of ruin can be severe when we consider a concentrated portfolio of highly correlated securities.
For example, a security has a 20% weight in its respective portfolio, and then subsequently suffers a severe shrinkage in value. This outsized effect of a large loss in a concentrated portfolio can be mitigated by diversifying/increasing the number of securities in the portfolio.
Research shows adequate diversification comprises 10-30 securities. There is minimal benefit from diversifying beyond 30 securities since securities in the same asset class are generally about 60 percent correlated with each other. Absolute minimum of 5 securities for those investors seeking a highly concentrated portfolio and optimal diversification of roughly 20-25 securities.
There is a necessity of allocating capital intelligently and with discipline in a diversified way in undervalued non-correlated securities.
Non-correlated asset allocation in theory entails the investment in securities of different asset classes that have low correlation or are inversely correlated, as defined by a security of one asset class increasing in value while a security of a different asset class decreases in value.
Contact The Practical Contrarian if you are a family office or other financial institution that has questions about what it means to allocate capital in a diversified non-correlated way.