A retail investor holds a portfolio distributed across 100 different domestic stock mutual funds, representing thousands of public companies across all equity sectors and market capitalizations. During a prolonged macroeconomic tightening cycle characterized by elevated interest rates and falling stock indices, the market value of the entire portfolio declines significantly. The investor is surprised by the losses, believing that spreading capital across so many equity funds would provide complete loss protection. Which of the following statements best explains why this diversification strategy failed to protect the investor's portfolio?
- ASpreading capital across additional equity mutual funds completely eliminates market risk once a portfolio exceeds 50 distinct fund holdings.
- Asset diversification mitigates unsystematic (business-specific) risk, but cannot eliminate systematic (market) risk driven by broad macroeconomic factors.Cevap
- CThe portfolio losses were primarily caused by issuer credit and default risk, which inherently increases across all equity holdings during rate hikes.
- DRising interest rates cause yield curves to invert, automatically requiring open-end mutual fund managers to liquidate stock positions to satisfy debt covenants.
Cevap
Asset diversification mitigates unsystematic (business-specific) risk, but cannot eliminate systematic (market) risk driven by broad macroeconomic factors.
Diversification across many individual stocks or mutual funds successfully eliminates unsystematic (nonsystematic or business) risk. However, systematic risks—such as market risk, interest rate risk, and inflation risk—impact the entire market simultaneously due to broad economic forces. Therefore, expanding diversification across equity funds cannot protect against systematic market downturns.
Adım Adım Çözüm
Anahtar Kavram
Systematic risk (market risk) affects the broad economy and financial markets, making it impossible to eliminate through asset diversification.