Correlation of a Portfolio

An investor owns two mutual funds. Fund A has an expected return of 8% and a standard deviation of 10%; Fund B has an expected return of 12% and a standard deviation of 20%. The correlation between the funds is 0.4. Which of the following statements is most accurate?

1. Combining the two funds will not reduce portfolio risk because they are positively correlated.
2. Combining the two funds will likely reduce portfolio risk compared to investing in Fund B alone.
3. The correlation of 0.4 means the funds move identically 40% of the time.
4. Fund B will always provide a higher risk-adjusted return because it has the higher expected return.