At a glance

  • The US now accounts for 73% of the developed markets MSCI World index1
  • Second quarter results for the Magnificent 72 tech companies continued to reflect solid growth
  • Diversification is an effective long-term strategy to minimise the effect of market shocks.

In an uncertain world, investors should consider the possibility of a less attractive market outlook. Furthermore, recent US Q2 earnings updates show that apart from technology, led by the very large companies often referred to as the Magnificent 7, the outlook for many sectors is subdued. This imbalance could prove uncomfortable and ways to smooth the ‘ride’ are more important than ever.

The value of diversification

Diversification is the financial equivalent of not putting all your eggs in one basket. It works by spreading money across a broad range of investments. A well-diversified portfolio may include shares and bonds, as well as more specialist investments such as commodities and property.

The idea is that weaker returns from one or more investment is offset by stronger performers elsewhere. This helps protect investors from volatile markets, aiming to smooth performance over time.

However, simply buying different shares or bonds is not diversification. Diversification means not concentrating too much in one area. This is because assets in the same sector, asset class or region will often behave in a similar manner. For example, buying several British energy companies won’t provide much diversification benefit if the price of oil drops.

Different approaches to diversification

A popular investment approach is to allocate 60% of funds into shares and 40% to bonds. This is known as the 60:40 approach.

Returns in government bond and equity markets usually move in opposite directions. In fact, ultimately the relationship between them depends on the growth and inflation outlook. Higher growth usually supports shares, while interest rate cuts support bond prices.

However, there is no guarantee this inverse correlation works all the time. In 2022 US shares and bonds both ended the year in the red, as the US Federal Reserve raised interest rates to combat inflation at a 40-year high, while the economy struggled with geopolitical and supply-side shocks.

The investment pyramid – balancing risk

A well-diversified portfolio is constructed much like a pyramid, with low-risk investments making up the base. This section would typically see the highest allocation and include government bonds (which can be turned into cash quickly) as well as cash deposits.

Rising up the pyramid and the investments will offer higher potential returns but also increase the risk for investors. These typically make up a smaller proportion of the portfolio than the base.

Investments potentially delivering the best returns are at the top of the pyramid. These could include growth or small-cap stocks, as well as alternative assets like commodities or property. While they offer the potential to achieve more attractive returns, they are also the most risky.

Different environments benefit different sectors

Diversification spreads the risk in investing by balancing the characteristics of different investments. Here are some of the more common ones:

  • Defensive sectors comprise businesses that deliver steady, regular earnings growth, regardless of the state of the overall economy. Pharmaceuticals and utilities, for example, are defensive sector mainstays. Consumers will still need drugs and medicines, and will continue to use gas, water and electricity at home, for example.
  • Banks and manufacturing companies often perform well when the economy is doing well or recovering following a downturn. These companies tend to follow the fortunes of the broader economy. For example, banks can lend more when the economy improves, while industrial companies should see more orders.
  • Oil and gas companies are often some of the first to rise when the economy improves, as their raw materials are needed quickly. On the other hand, they are vulnerable to geopolitical shocks or slowing economic growth.
  • Fast growing sectors such as technology and communications tend to perform strongly when the economy is doing well. They will often have a lot of borrowing so are affected by interest rates.
  • Bonds provide regular income and have historically performed well in periods of economic uncertainty. They are considered a steady counterbalance to shares.

Diversification in action – emerging markets

It was not so long ago that emerging markets were dominating returns. Following China’s entry into the World Trade Organisation in 2001, its economy grew rapidly. This benefited a broad number of other emerging markets (EM), such as South Africa and Russia, which supplied it with raw materials.

Yet in recent years, investors who concentrated on EMs at the expense of developed markets (DM) would have seen their returns trail significantly. Since the 2008 financial crash, DM have outperformed EM significantly. DM have been helped by stronger earnings and better governance, a stronger US dollar and a low-interest rate environment. The growth in technology stocks in this period has notably contributed to the idea of ‘American exceptionalism’.

Do we still need diversification?

Market moves are often unpredictable and there are periods when investors would have benefited from being less diversified. For this reason, a diversified portfolio should not be considered a magic bullet.

The past few years has not been kind for investors favouring a diversified global portfolio. The continuing outperformance of the tech sector in the US has benefited investors who have chosen a concentrated investment approach.

True diversification is becoming increasingly difficult dues to globalisation. There are now many more links between different assets, companies and products all over the world than in the past. Yet that doesn’t reduce diversification’s importance – if anything it makes it more valuable.

Without diversification, generating strong returns over time would mean consistently predicting which markets and sectors will be next to outperform, and those that are set to struggle. This is extremely difficult, even for professionals. While investing in particular sectors can generate spectacular returns over short periods, over the long-term, returns will almost inevitably slow.

Steady positive returns are an investor’s friend. Over the longer-term, a diversified portfolio will often perform more consistently than a concentrated one.

Sources

1MSCI World Index composition. MSCI data as of 31 July 2025
2The Magnificent 7 is the name often given to a strongly performing handful of very large US technology companies. The group includes Alphabet, Amazon, Apple, Broadcom, Meta Platforms, Microsoft and Nvidia.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

Past performance is not indicative of future performance.

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.

Source: MSCI. Certain information contained herein, including without limitation text, data, graphs, charts (collectively, the “Information”) is the copyrighted, trade secret, trademarked and/or proprietary property of MSCI Inc. or its subsidiaries (collectively, “MSCI”), or MSCI’s licensors, direct or indirect suppliers or any third party involved in making or compiling any Information (collectively, with MSCI, the “Information Providers”), is provided for informational purposes only, and may not be modified, reverse-engineered, reproduced, resold or redisseminated in whole or in part, without prior written. 

SJP Approved 28/08/2025