Equity markets have rebounded strongly from the falls of February and March 2020, to deliver significant outperformance to investors.
Most of the returns have been generated by a few US technology stocks though, which have been riding high on the back of the global shift to remote working.
“The Covid-19 crisis exacerbated market concentration within the S&P 500 [index], resulting in a cohort of just a handful of tech stocks making up more than 25 per cent of the index. These stocks drove markets higher as investors looked for clarity on future earnings and jumped onboard the ‘stay at home’ theme,” says Shane Balkham, chief investment officer at Beaufort Investment.
But in relying on this small subset of stocks for future returns, investors’ equity exposure may not be genuinely diversified.
Looking beyond the stocks that are currently performing well to those that might deliver outperformance in the future can be challenging, as Adrian Lowcock, head of personal investing at Willis Owen, acknowledges.
He adds: “Sometimes you do need to say, ‘OK they’ve done very well, but they’re not going to perform year in, year out relentlessly’.”
For investors, overcoming the psychological barrier of breaking away from the herd can be difficult.
However, this is an important part of diversification as Ben Kumar, senior investment strategist at 7IM, explains: “Being prepared to hold something that is different from the consensus can feel uncomfortable, but that uneasiness is also the sign that not everything in the portfolio is pulling in the same direction, which is what diversification is all about.”
Time to diversify
There are a few ways to achieve diversification, such as by investing across geographies or asset class type.
Lowcock suggests that being diversified by region is an “easy win”, although can be complicated by the fact that companies are becoming more “globalised”.
“The one that often gets overlooked – and this is where multi-asset does come in and adds quite a lot of value – is by style. And this absolutely talks to backing the next winners, if you like, or the next phase of the cycle because investment style does come in and out of favour,” he says.
Even in environments where one style has dominated, those approaches that lagged will not have lost investors' money and typically still have generated a positive total return, he adds.
Minesh Patel, a chartered financial planner at EA Financial Solutions, agrees: “When clients are seeking to invest in a balanced equity portfolio that is genuinely diversified, they should invest in multi-asset funds that invest in a range of investment styles: growth, value, momentum. They will then invest in a range of companies that are not so closely correlated.”
On the income trail
Equities can also contribute meaningfully to income as well as to growth in a multi-asset portfolio, as Tom Mills, senior investment analyst at Hargreaves Lansdown, observes.