One of the main reasons why businesses diversify across business risk is because they are preventing the likelihood of failing and going bankrupt.  As an example, firms often invest in hedge funds that from an operational perspective, examined in isolation, are risky- as are technology stocks, energy trading companies or airlines.  However, most investors within the firm do not hold single portfolios.  They diversify stock-specific risk (known as NON-systematic risk) by investing in a range of stocks with different characteristics.  Most of these investors regard it as unwise not to diversify into NON- systematic risk.  It is similarly known to be unwise not to diversify risk to a single hedge fund, or mutual fund. The advantage to investing into a hedge fund is that they can offer an attractive opportunity to diversify an investor’s portfolio of stocks and bonds.  The main idea behind diversifying your NON- systematic risk into areas such as hedge funds is that any investment with a positive expected return, low volatility and low correlation to the rest of the portfolio, will have a great chance of reducing the portfolio volatility. The investment strategy of diversifying NON- systematic risk into a stocks and bonds is that the financial risk to the investor might be directional.  Many hedge funds are speculative financial instruments or techniques to manage conservative portfolios (eg. short selling and leverage).  Not everyone understands this.  Popular belief is that an investor using, for example, leverage instruments, must be a speculator.  The reason why this is a misconception is that the speculative instrument is most often used as a hedge, that is, as an offsetting position.  The incentive to use such an instrument or technique (example: short selling) is to reduce portfolio risk (NON- systematic), not to increase it.   The important thing to realize is that systematic risk cannot be eliminated by diversification, and NON- systematic risk can be.  The unsystematic part of the total risk is easily eliminated by adequate diversification.  So, there is no reason to think that investors will receive extra compensation for bearing unsystematic risk.  The only part of total risk that investors will get paid for bearing is systematic risk.  So, while all risk is important to consider, the real value comes from when financing managers engage in strategies that can produce the appearance of return enhancement.  In doing so, underestimating systematic (market risk) risk, can result in an overweight allocation of funds in the NON- systematic investment.  Thus, it is important to distinguish between both risk factors, short volatility, and illiquidity. Bibliography The New Generation of risk Management for Hedge Funds and Private Equityhttp://books.google.com/books?id=2w0bRIv7cygC&pg=PA30&dq=non-systematic+... NON- Systematic risk. The Known Market Risk.http://www.library.fullerton.edu/asp/EZCheck.aspx?URL=http://xerxes.cals... A non- Gaussian Panel Time Series Model for estimating Default Risk.http://p9003-sfx.calstate.edu.lib-proxy.fullerton.edu/fullerton?url_ver=...