Stock market investors seek diversification for a multitude of reasons. Stock specific risk can be diversified by increasing the number of holdings in order to mitigate the effects of a blow up in any particular stock. However, the greater challenge lies with eradicating systematic or market risk.
Market risk can never be totally eliminated within a stock portfolio however it is possible to decrease the level of correlation within a portfolio. For example, investors could favour small caps over large caps. This is feasible because it is possible to find stocks whose earnings are less exposed to the economy at large. Indeed, it is easy to find counter-cyclical stocks within the small cap universe.
Another option is to reduce the number of holdings and have a few ‘focused’ positions. However, this approach will increase stock specific risk, so it is hard to argue that it is reducing risk.
