Explain the differences in how modern and traditional theories of portfolio management approach the issue of diversification

What will be an ideal response?

Answer: The modern approach to portfolio diversification uses computers to analyze a large number of investment alternatives, mathematically seeking minimum correlation and maximum return. Ideally these methods identify portfolios on the efficient frontier with minimum portfolio betas or standard deviations for the expected level of return.

The traditional approach to diversification uses human judgement and experience to choose a diversified combination of stocks and other securities across industry lines and possibly national borders. When done well, this approach also reduces risk without excessively sacrificing return. The traditional approach may lead to overinvestment in the stocks of large, well-known companies because they most readily come to mind for the manager, because the manager fears criticism for omitting them, or wants to avoid blame for less conventional choices (window dressing).