VALUE IMPACT OF PORTFOLIO DIVERSIFICATION
CHEW LAY KHIM
CHEW LAY KHIM
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Abstract
Portfolio diversification has received substantial attention from both the academic and business community. However, the literature has been skewed towards examination of the correlation coefficient to evaluate the effect of portfolio diversification, with less attention paid to the overall value impact on the company. There is also contrary view as to whether diversification by geographical location or property type is a better diversification strategy.
The objective of the research is to investigate the validity of the resulting diversification strategies by examining the value impact of diversification by geographical location and property type on the local companies.
It is concluded from the empirical result that diversification by geographical location does not improve the value of the company and diversification by property type may improve or deteriorate the value of the company. This suggests that despite Harry Markowitz Modern Portfolio Theory which states the possibility of enhanced portfolio return and risk reduction from portfolio diversification, this does not necessary translates to overall value enhancement for the company.
Portfolio diversification introduces management complexities to the organizational structure which requires additional time and cost, sophisticated management system and advanced managerial expertise to achieve operating efficiency. Geographic diversification poses potential negative influences such as foreign exchange rate risk, economic risk, political risk and increased asymmetric information, which lead to an increase in systematic risk. This mitigates the enhanced portfolio return from global diversification and deteriorates the value of the company. Portfolio diversification discounts value when economie of scale is not achieved or through misallocation of funds or over-investment in value-destroying projects. All these activities lead to diminution in the value of the company. Moreover, an investor can diversify the portfolio himself when each individual company is not diversified.
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Date
2006
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