FWB - The surprising power of diversifiers

Diversification, whether in portfolios or teams, is surprisingly powerful but sometimes misunderstood.

I love thought experiments (John Southall, Head of Solution Research, Legal & General Investment Management). Imagine you can own either:

(A) 1,000 assets, each with an annual volatility of 10% and each 50% correlated to every other asset in the portfolio; or

(B) Just two assets, each with an annual volatility of 10% but with a correlation of zero to each other.

In both cases, the assets are equally weighted within the portfolios, so portfolio (A) has 0.1% invested in each asset whereas portfolio (B) has 50% invested in each asset.

Which, intuitively, would you say has lower volatility – portfolio (A) with 1,000 assets or portfolio (B) with just two?

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