Diversification Strategy
The foundation of asset allocation as we know it is the concept of diversification strategy and the science of Mean Variance Optimization, or MVO. First introduced by Nobel laureate Harry Markowitz some 50 years ago, MVO is a quadratic search utility that constructs a portfolio that maximizes the ratio of its returns—the mean—to its variance—usually standard deviation. Once optimized, a portfolio’s components combine to reduce volatility because of imperfect correlations among the individual assets. In this way, MVO indirectly uses a diversification strategy to create better portfolios. This indirect diversification strategy, however, is essentially channeled through the assets’ volatilities. The MVO process, in other words, looks at diversification through ‘risk-colored glasses’.
The MVO process, then, because by definition it optimizes for risk, leaves a good measure of diversification on the table by favoring low volatility assets.
Despite its limitations, MVO has been the best, maybe the only, portfolio diversification strategy available. But recent advancements in the science of diversification measurement and optimization by Gravity Investments have given investors an entirely new choice: To specifically optimize a portfolio for diversification.
Gravity has constructed a measurement of diversification known as the Intra-Portfolio Correlation (IPC). This patented measure produces the weighted average of all unique correlations in the portfolio and provides a measurement of diversification specifically tuned to systematic risk. The process employs a three-dimensional diversification platform called Gsphere to produce diversification optimization analytics.
