Diversification: What It Does and What It Does Not Do

Diversification removes the risk of a specific company and does not remove the risk of the market. By spreading your money across different issuers, you stop depending on what happens to an individual plant, court case or management team: the failure of one name is diluted by the rest. But everything that acts on the market as a whole — the interest rate, the rouble exchange rate, commodity prices, the tax regime, infrastructure constraints — acts on a broad portfolio too, and adding one more ticker does not help here. What follows is about where exactly that boundary lies and how to check that your portfolio is diversified in more than appearance.

The mechanism: which risk gets diluted

The risk of any security breaks down into two parts. One belongs to the company itself: an accident at a production site, the loss of a contract, a change of owner, a decision not to pay a dividend. Such events are independent of each other — bad news about a steelmaker does not move a retail chain. When there are many independent sources, their deviations cancel each other out, and the contribution of each to the overall result becomes small. This is the work diversification does, and it comes free: breadth does not require giving up the portfolio's expected return, it only requires giving up a concentrated bet.

The other part of the risk is common to all: the key rate, access to capital, export demand. It cannot be diluted, because there is nothing to dilute it against — all the components move in one direction at the same time. Hence the practical conclusion: a portfolio assembled "just in case" from a multitude of names falls in a crisis almost as much as the market does, and this is not a malfunction but exactly what the mechanism promises.

Count factors, not names

The most common mistake is to measure diversification by the number of tickers. The Russian market is concentrated by source of revenue: a considerable share of the capitalisation in equities is tied, in some way or other, to commodity exports and to the rouble exchange rate. A portfolio of an oil producer, a gas producer and a steelmaker is broad on paper, yet in practice it is one bet on the commodity cycle, spread across different nameplates.

What deserves checking is not the list but where the companies get their money. An exporter gains from a weak rouble; an importer and domestic retail lose. A bank lives on the interest rate and the quality of the borrower; a property developer on the interest rate and subsidised mortgage programmes; a power utility on the tariff. The source of revenue is visible in the financial statements, while the sector and the valuation multiples are on the security's page: {{instrument:SBER}}, where the current value of the metric stands next to its history — 3,71.

Bonds: a different factor, but not a safe haven

Adding bonds changes not the number of names but the nature of the risk: instead of a share in the profit, you hold an obligation to repay the face value. A corporate issue and a share of the same issuer are linked through its credit quality — this is not diversification but the same bet on a different rung of the seniority ladder. OFZ take you out of corporate risk but immerse you fully in interest-rate risk: when the rate rises, long issues are repriced downwards, and this happens in the very periods when equities are falling. The short end of the curve behaves differently — and that is the distinction within debt that actually works.

Funds: breadth in one trade, and its price

Funds give broad coverage without assembling a portfolio by hand. In exchange you give up a fee and control over the composition: an index fund inherits the concentration of the index itself, and if the index is skewed towards a few heavyweight names, the fund is skewed in exactly the same way. The breadth of a fund is the breadth of its underlying base, not a property of the wrapper.

What diversification does not do

It does not protect against a general fall in the market — this has already been said above, and it is the main limitation. It does not protect against a depreciation of the rouble if all the assets are rouble-denominated. It does not remove infrastructure risk: securities held in one place of custody share the fate of that place, however many of them there are. It does not guarantee cash flow — the decision to pay is taken by each company separately, and the dates can be seen in the dividend calendar: {{dividend_calendar|limit=5}}. And it is no substitute for understanding: a broad portfolio of securities you know nothing about still remains a portfolio of securities you know nothing about.

How to check a portfolio

Step 1 — write down what drives the revenue of each position: commodities, the interest rate, domestic demand, the tariff. Step 2 — group the positions by these factors, not by industry; if after grouping almost everything has ended up in one group, you have no diversification, regardless of how long the list is. Step 3 — decide which of the remaining risks you hold deliberately and which you acquired by accident; the accidental risk is worth cutting, the deliberate risk is not — it is the risk you expect to be paid a premium for.

The terms that came up above are explained in the glossary; the events that force a review of a portfolio's composition are in the news feed.