Measuring the Benefits of Diversification and the Performance of Money Managers

11 Pages Posted: 5 Nov 2010

See all articles by Meir Statman

Meir Statman

Santa Clara University - Department of Finance

Jonathan Scheid

Bellatore Financial, Inc.

Date Written: Winter 2005-2006

Abstract

While correlation is the common measure of the benefits of diversification, it is not a good measure. This is for two reasons. First, the benefits of diversification depend not only on the correlations between stock returns but also on the standard deviations of stock returns. Second, correlation does not provide an intuitive measure of the benefits of diversification. Dispersion is a better measure of the benefits of diversification. Dispersion is the standard deviation of the returns of stocks around the mean return of all stocks. We know dispersion as diversifiable risk and as tracking error. We analyzed the returns of the S&P 500 stocks during the years 1980–2004 to show how dispersion measures the benefits of diversification and how to account for dispersion in the assessment of the performance of money managers.

Keywords: Diversification, Correlations, Dispersion, Tracking Errors, Portfolio Theory

JEL Classification: G11, G14

Suggested Citation

Statman, Meir and Scheid, Jonathan, Measuring the Benefits of Diversification and the Performance of Money Managers (Winter 2005-2006). Journal of Investment Consulting, Vol. 7, No. 3, pp. 21-31, Winter 2005-2006. Available at SSRN: https://ssrn.com/abstract=1702410

Meir Statman (Contact Author)

Santa Clara University - Department of Finance ( email )

500 El Camino Real
Santa Clara, CA 95053
United States
408-554-4147 (Phone)
408-554-4029 (Fax)

Jonathan Scheid

Bellatore Financial, Inc. ( email )

1550 The Alameda, Suite 310
San Jose, CA 95126
United States

HOME PAGE: http://www.bellatore.com

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