In this topsy-turvy world of investment where the Magnificent Seven, AI and FOMO dominate and markets have been hitting new all time highs, what are the risks we need to bear in mind? Fabian Wiesner (pictured), Head of Distribution Partnerships, SimplyBiz, offers us his practical insight into how and why diversification really does matter when it comes to building robust investment portfolios for clients that stand the test of time –whatever the weather!
I’d suggest that some of the most dangerous words in life are “This time it’s different.” Initially we might believe it, however, in my experience, these words should be accompanied by a mildly sceptical eye. However, this time it will be different when I try is something particularly true in the world of investments.
It’s easy for us to tell ourselves that the yearlong rally we’ve seen, carried by the AI trade and the “Magnificent Seven,” is different this time. “The fundamentals are strong”, “Major companies are upgrading their tech stacks”, “businesses are adopting AI” etc. Whilst these statements may be true, a sceptical eye needs to be cast across the rest of the markets to understand what is going on beneath the surface too.
Most focus fell on the U.S. markets in 2023, and for good reason. In 2023, the S&P500 (Broad U.S. equities) and the Nasdaq-100 (Tech heavy) indices moved up 24% and 51% respectively, and YTD they have moved up by circa 6% and 7.8% too. This is wonderful news for all clients that have been invested in these areas through those time periods. However, when we do start to cast a cynical eye over these markets, we see just how much the Magnificent Seven were really carrying returns.
At the time of writing:
- 235 of the 503 companies in the S&P 500 are in negative territory YTD (year to date)
- 42 of the 101 companies in the Nasdaq100 are in negative territory YTD
- Meta, Nvidia, Microsoft, Google, Tesla, Apple, Amazon, make up about 30% of the S&P500.
These are not insignificant numbers. I’ve never been a big fan of market cap weighted indices as a barometer for overall health of investments markets. To me, they passively hide the broader picture. Every time I hear ‘New record high’ or similar statements, it automatically makes me think about what is really driving those markets to those lofty heights. In recent months it’s been seven mega-companies. I prefer my news honest “Seven companies carry the weight of all portfolios – the rest OK at best” would seem more accurate.
The importance of diversification
This really starts highlighting the need to have genuine diversification in our investment holdings. Passive investors may not be aware of just how much of these companies they hold, and the concentration risk associated with holding such heavy weightings. In February, Nvidia reported blockbuster earnings after the market close on 21/02/24. Before the announcement shares fell dramatically. As a result of the news, the share price was up over 15% over a 24-hour period to market close on 22/02/2024. This prompted a broad stock rally in U.S. equities. Let’s be clear – this is still not healthy market behaviour, although this seems to be what the market is hanging its hat on as a gauge for the next phase of 2024.
But why are we all watching one company so closely to validate an entire stock market?
Don’t look back in anger
I realise that all of the above may seem to be overly pessimistic, however that’s not the intent. What I’d like it to point out is that moving through this year there is cause to look at the investments we hold for clients and assess if there are any risks hidden in there for which we’ve not accounted. Most clients will happily turn a blind eye to these risks when the good times are in full swing. However, if we enter into a period of volatility, volatility being coupled with the backdrop we are facing might make those very same clients nervous.
Some might say…
Some might question the backdrop I’m referring to. The U.K. is now in a technical recession, and it feels that more and more regularly we are hearing of companies cutting back on spending or staff, a long lingering hangover from high inflation, high borrowing and repayments costs, lower consumer confidence, 0.6% UK economic growth projection for 2024, and the potential (and seemingly likely) change of governments both at home and abroad to name but a few. These factors don’t make for a stable backdrop, especially as clients start to see and hear more about them in the media.
Definitely, maybe
There is a lot of hope being pinned on Central Bank rates coming down this year, from both the Bank of England and The US Federal Reserve. However, let’s also just remind ourselves the reason rates are cut is to stimulate an economy that’s not doing so well. This is where the “Hard” or “Soft” landing question comes into play – and the jury is still out on that.
When these new headlines are so close to home, it’s the real-world consequences that our clients will face. The sensational headlines won’t protect pension pots or ISA valuations. More now than ever there’s a good prompt to look at what clients are holding. The trend of blending multi-asset funds is great – adding diversification. However, how many of us are looking to see what these funds are holding? Are we blending four funds with the same top ten holdings? Is that a good idea?
We love the word diversification, the idea of diversification, talking about diversification, but really what we love is returns.
If this time really is different, then the worst-case scenario in doing more homework, and checking our biases, is that we know more about what’s out there. Best case scenario is that we’ve put our clients into the right holdings to protect them when the going gets tough.
Will this time be different, or will we eventually see the Magnificent Seven cast aside for life boats? I have an unsettling feeling we will know sooner than we think.
About Fabian Wiesner
Fabian Wiesner joined SimplyBiz in September 2023 to manage its relationships with its investment strategic partners and develop and strengthen its comprehensive investment supply chain for member firms. He also sits on its Investment Committee, with a focus on strengthening the SimplyBiz Risk Controlled offering, a proposition that is designed to help advisers manage their investment supply chain and clients’ investment portfolio risk.
