If a strategic AA contains large-cap and small-cap, are asset classes correctly specified?
CFAI seems to be contradictory in this respect. I’ve done some questions in which they say correlation is that high that are not diversifiable, and others indirectly accept it.
However, Asset Allocation - Kohler says midcaps are not.
Roth would most likely criticize the specification of mid-cap equities because they are not mutually exclusive with respect to domestic large-cap and small-cap equities. Asset class specification should support the purposes of strategic asset allocation. Domestic large-, mid-, and small-cap equities are assets within the asset class of domestic equities and have little diversification benefit between them, with the correlation between their returns being very high. Five criteria are helpful in effectively specifying asset classes:
1. Assets within an asset class should be relatively homogeneous.
2. Asset classes should be mutually exclusive.
3. Asset classes should be diversifying.
4. The asset classes as a group should make up the preponderance of world investable wealth.
5. The asset classes should have the capacity to absorb a significant fraction of the investor’s portfolio without seriously affecting the portfolio’s liquidity.
CFA Level III
“Asset Allocation,” William F. Sharpe, Peng Chen, Jerald E. Pinto, and Dennis W. McLeavey