Investment diversification as a strategy for reducing investment risk

Abstract

Investment diversification is a widely accepted investment strategy, aimed at reducing investment uncertainty, while simultaneously keeping the expected return on investment unaltered. The development of investment diversification coincided with the development of portfolio theory. At the time when traditional portfolio theory was recognized as the leading portfolio management practice, the simple diversification of investments was the most commonly used strategy; however, due to its inability to recognize the importance of the correlation between returns on different investments, simple diversification was later rejected in modern portfolio theory and replaced with efficient diversification. The research study is aimed at conducting a comparative analysis between the simple and efficient diversifications of investments, together with the inevitable analysis of the optimal number of securities in a portfolio and the testing of the validity of the international diversification of investments. By applying a qualitative research methodology, it is concluded that the benefits of the international diversification of investments are still substantial, and as such outweigh specific limitations, and that the number of securities in a portfolio should be increased as long as its marginal benefits, in the form of reduced investment risk, exceed its marginal costs-in terms of increased portfolio management costs, which also represents the main result of the research.

Islamic Capital Market Integration and Asymmetric Information: A Study in the Five Asean Countries From the Post-Global Financial Crisis

“…As such, these results are consistent with Hypothesis 1. These results also support Lekovic (2018), who states that a portfolio containing a specific number of stock indices from the selected countries enjoys lower total portfolio risk, including lower asymmetric information (see also De Santis & Sarno, 2008;Bekaert et al, 2009). Overall, using dummy variables of two-country portfolios to test the effect of Islamic capital market integration on asymmetric information among the five ASEAN countries is theoretically reasonable and empirically supported.…”

“…These findings also imply that the strongest Indonesia-Malaysia linkage of the Islamic capital markets has also prominently and negatively affected asymmetric information (as reflected on bid-ask spreads). The dummy variables of the two-country portfolios that reflect stronger Islamic capital market integration have a significant and negative impact on asymmetric information among the five ASEAN countries (see Lekovic, 2018;De Santis & Sarno, 2008;Bekaert et al, 2009) more consistently than those that reflect weaker capital market integration (e.g., between the Philippines and any other four ASEAN countries). Thus, these results support Hypothesis 1.…”

“…Islamic capital market integration is carried out to reduce risk; this is indicated by asymmetric information (proxied by the bid-ask spread of stock prices). Lekovic (2018) posits that when foreign securities are included and mixed with one's domestic investment in a portfolio, part of systematic risk in the domestic market is transferred into unsystematic risk, while the rest of systematic risk remains unchanged because of global macroeconomic variables as common factors that cannot be diversified. This unsystematic risk, among other things, may stem from asymmetric information because of institutional, regulatory, or monetary differences between domestic and foreign markets or the differences between the more-informed investors from domestic countries and the less-informed investors from foreign countries.…”

“…Keeping in mind the findings of Qizam et al (2020), the two countries of Indonesia and Malaysia are found to enjoy the strongest integration, while the weakest integration contrarily occurs in the integration between the Philippines and any other country. Lekovic (2018) confirms that combining some stock indices from selected countries in a portfolio will generate better benefits from international diversification because of lower correlation and lower total portfolio risk (including lower asymmetric information) than combining all stock indices from countries all over the world or a single country (see also De Santis & Sarno, 2008;Bekaert et al, 2009). It means that through integration involving different stock indices in different countries, that is, a two-country portfolio as a dummy variable, total portfolio risk, specifically unsystematic risk sourced from asymmetric information, will also decrease, but the combination of two-country portfolios will certainly generate different levels of integration.…”

“…Previous studies were not only conducted in the specific regional areas (ASEAN, European Union, MENA, or other regions) but also had involved a broader context (international), for example, the extent to which the integration of capital markets among developed countries and global capital market has an impact on capital markets in developing countries with a variety of research models (see Swanson, 1987;Click & Plummer, 2005;Simpson, 2008;Majid et al, 2007;Siddiqui, 2009;Kabir et al, 2013;Rangvid et al, 2016;Chevallier et al, 2018;Miyazawa et al, 2019;Caporale et al, 2019;Tinta et al, 2018;Nittayagasetwat & Buranasiri, 2018). Besides, capital market integration has been also proven to bring many benefits, e.g., an increase in liquidity (Singh, 2009), the more efficient resource-allocation for improved productivity and more access to investment opportunities (Bonfiglioli, 2008;Gehringer, 2013), the easier rather than a single country portfolio is also considered a distinctive approach to measure levels of capital market integration (De Santis & Sarno, 2008;Bekaert et al, 2009;Lekovic, 2018). Given that argument, this study aims to examine empirically the impact of the Islamic capital market integration (using a two-country portfolio as a dummy variable to measure Islamic capital market integration levels) on asymmetric information among the five ASEAN countries, following up on the findings of Qizam et al (2020).…”