A New Look at Diversification.

A new look at diversification:

In basic materials, only diversified companies approach an efficient portfolio’s risk–return performance, since they can exploit negative correlations among the business cycles of different commodities.

Should managers ever diversify their companies on the shareholders’ behalf? The underperformance of many conglomerates has given diversification a bad name. In any case, most investors can, if they wish, independently assemble a set of assets lying on or near what financial theorists call the "efficient frontier," which represents the highest return for a unit of risk. Nonetheless, some evidence suggests that a moderately diversified company performs at least as well as—and in some industries better than—more focused ones*. Consider the basic-materials industry: only diversified companies approach the risk–return performance of an efficient portfolio, for unlike their more focused counterparts, they can exploit negative correlations among the business cycles of different commodities. This flexibility allows such companies to pursue opportunities, even when times are bad for some of their businesses, by adjusting their investments toward more attractive projects or regions. Since many basic-materials businesses require similar skills, diversification doesn’t have to take these companies far afield.
**Ref:Michael Dalby and Timo S. Smit2004 Mckinsey Quarterly.