Having a large US and technology exposure may not cause widespread investor concern, but in fact may seem quite appealing. A recent Citigroup survey showed that over 40 per cent of investors want to be overweight US equities over the next 10 years.
And technology companies are still well-loved and have shown resilience during the pandemic as the world relies on their services to work, buy vital goods, and connect with loved ones.
Of course, the technology sector is in favour and may continue to be in the short-term but history tells us that market leadership will eventually change hands and the stocks with the largest market cap at any point in time are unlikely to be the main protagonists a decade later.
In addition, if index investors want exposure to the technology sector, it could be done in a more diversified way.
Ironically, these index investors have become accidental active investors in a more concentrated way than many of the actively managed strategies we see in the market by allocating substantial capital to a handful of stocks.
As it is incredibly difficult and inadvisable to time the market in order to avoid any potential losses, we would stress the importance of a foundation of diversification to spread risk across different countries and asset classes.
How to achieve true diversification
Index trackers are growing and are vital for investors to get the cost-effective exposure they need in their multi-asset portfolios.
But they should also account for the potential pitfalls of concentrated indices.
Instead of investing blindly in a global equity index, it is important investors use regional equity indices to spread the risk across geographies therefore avoiding excessive concentration or stock-specific risk.
A more balanced allocation can then be implemented.
Hindsight is the mental curse of diversification
Just as there will always be an individual equity that outperforms all the others, there will always be an asset class that outperforms within a diversified portfolio. In 2019, that asset class was US equities for many multi-asset investors like myself.
The temptation is to believe, with hindsight, that this outperformance was inevitable and the winning strategy was obvious; that in this instance, putting all the eggs in one basket was a good strategy.
However, we know that over the long term, the winner last year is not necessarily going to deliver the same outperformance the following 12 months.
Always bet on the house
Some view investing as making a series of bets. In reality, being a truly diversified investor is a bit more like owning a casino, rather than being a gambler at one of the tables.
