Question

In crisis periods when markets are falling sharply, such as those we have seen in recent weeks, there is a tendency for assets which usually have relatively low correlations to start to move together much more strongly. Evaluate the impact of this empirical regularity on the ability of investors to diversify and thus how diversification opportunities vary with market conditions

Answer 1

Assets who have a low correlation are providing with the better diversification opportunity and they will provide a defensive investment at the time of the crisis so, at the time of the crisis these shares generally outperform the general market because they have a low correlation and they are highly defensive in nature.

These shares who have low correlation to the market do not follow the market, because they are highly strong with their own for specific factors and they are driven by their firm specific factors, so they are highly defensive share and they see a lot of inflow of money at the time of crisis because all those aggressive stocks who are high beta stocks are falling because the market is falling but these stocks are a perfect hedge against market.

Diversification helps investor to counter the adverse situations and make a Portfolio which will help to diversify all the market specific risk so he should be eliminating all the unsystematic risk and allocating resources in most suitable manner to to reduce the systematic risk as well