Investors face numerous challenges including from the influence of disruptive technology and AI, climate change, and historically high market concentration. In the following analysis, Paul Niven, Fund Manager of F&C Investment Trust, explains why a globally diversified approach is as relevant today as it has ever been:
“Markets today are unusually concentrated, with the US accounting for more than 70% of developed indices, and the Magnificent Seven alone representing almost a third of the US market[1]. This makes it harder than ever for investors to construct portfolios that are not overly reliant on a handful of names, however the events of this year have offered a timely reminder that market leadership can shift quickly.
“With inflation expected to moderate, policy easing anticipated and global growth holding steady, the outlook for risk assets remains reasonably constructive. Diversification provides a resilient way to navigate both opportunities and risks across markets.
Diversification reduces volatility and timing risks
“From an investment perspective, it can be challenging to assess the permanence of trends. The Covid pandemic is a good example of this, when it was difficult to identify the permanence of change. Despite this, investors ploughed money into vaccine makers like Pfizer, as well as companies like Peloton and Zoom[2] which were also thought to be well positioned to benefit from social change.
“Whilst profits for each surged in 2020, many of those gains have since reversed, with Pfizer falling by around 50%, and Peloton by 95%[3]. This highlights the risk of overexposure to short-lived themes and underscores the importance of diversification, which can help investors reduce vulnerability to transient trends
Capturing the winners, avoiding the losers
“It’s widely accepted that a very small proportion of companies generate the majority of long-term equity returns. Between 1926 and 2016, more than half of US stocks actually lost money or underperformed short-dated treasuries – the equivalent of cash. The picture was even more striking in global markets, where 61% of companies lost money relative to cash and just 1% of companies were responsible for driving overall index returns.
“F&C has successfully identified some of these rare winners, investing in Amazon[4] in 2006 when it was valued at $10 billion, and in Facebook in 2005 when it was worth just $100 million. Both are now worth hundreds of billions of dollars. But these are the needles in the haystack, and identifying such opportunities in advance consistently is extremely difficult.
“Instead of ‘searching for the needle’ or ‘buying the haystack’, the best option, in our view, is to adopt a diversified approach across multiple, focused, strategies. This increases the likelihood of capturing the winners while limiting exposure to the far more numerous losers. We saw this play out in 2024, when both our US value and growth managers identified investments well positioned to benefit from the increased demand for artificial intelligence. Our value manager identified Vertiv[5], a provider of cooling and power systems for data centres, while our growth manager held Nvidia, a leader in AI-driven graphic processing units. Both returned over 130% and 170% respectively, demonstrating the benefit of a blended approach that captures winners from different parts of the market[6]. This is particularly relevant at a time when returns are expected to broaden out beyond a handful of index heavyweights.
Spending risk efficiently
“Some argue that concentrated, high-conviction portfolios are superior to diversified ones, as holding only a small number of stocks can deliver returns comparable to the wider index. By contrast, adding more holdings is sometimes criticised as “diworsification,” diluting conviction with lower-quality picks. While it is true that a relatively small number of stocks can reduce absolute risk, highly concentrated portfolios still carry significant relative risk compared with market indices. In practice, concentration does not increase the likelihood of outperforming the index, but instead raises the probability of delivering returns that deviate sharply from the index – either positively or negatively.
Focusing on rewarded risks
“Even for the most successful professional investors, research shows that a key driver of outcomes is the decision over which part of the investment haystack they choose to search. Whether prioritising growth, value or quality, and how those potentially competing objectives are managed, has a significant influence on long-term returns.
“Our approach to diversification recognises that blending focussed strategies, invested by skilful managers with a clear mandate, will allow us to own a collectively diversified range of best-in-class companies while avoiding ‘unrewarded’ risks.
A proof statement for diversification
“This principle of diversifying exposure across a range of investments for F&C has ensured a robust underlying portfolio which has stood the test of time across various market cycles and economic conditions. It has enabled F&C to pay a dividend to shareholders in every single year since 1868 and a rise in annual dividends in each of the past 54 years[7].
“Today, the portfolio is diversified across countries, sectors, investment styles and both public and private markets. This diversification means that our returns are unlikely to top the performance charts one year, nor be bottom of the leaderboard the next. Investment trends will ebb and flow but the fundamental rules of investment are constant – diversification matters.”
[1] Columbia Threadneedle Investments / Bloomberg
[2] The mention of any stocks or securities is not a recommendation to deal
[3] Columbia Threadneedle Investments / Bloomberg
[4] The mention of any stocks or securities is not a recommendation to deal
[5] The mention of any stocks or securities is not a recommendation to deal
[6] Past performance does not guarantee future results. There are no guarantees dividends will continue to increase
[7] Past performance does not guarantee future results. There are no guarantees dividends will continue to increase
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