Advanced Diversification. That’s the mantra we live by at True Potential. Not slavishly jumping on the latest bandwagon, we construct portfolios from old and new investments, traditional and alternatives positioned for the future rather than relying on what has been.
One of the ever-present debates in financial services is that of active versus passive management. Does an experienced fund manager really secure you better returns than the lower cost algorithms of an index tracker?
The case for each is strong. We use both.
And each approach requires scrutiny. As an investor you need to know what you’re investing in. You need to look under the bonnet.
In truth the active/passive argument is much more nuanced. Some indices are easier to outperform than others. The UK market, with its large exposure to the Resources sector, has been relatively easy to beat if your call on oil and mining stocks has been right. America’s S&P 500, by contrast, has proved a more difficult nut to crack for various reasons.
It is the largest, most liquid market. It is subject to more analysis than any other market. No element of it remains unmeasured, unmetered or unmarked. It contains many of the leading companies in the largest and most rapidly expanding areas of the global economy, and in concentrations that few active managers would consider prudent.
While the S&P 500 may be perceived as a broad reflection of the US economy, a closer inspection reveals that a small number of stocks wield substantial influence over its performance. Around one quarter of the value of the index is comprised of a handful of stocks: Apple, Microsoft, Alphabet (Google), Amazon, Nvidia, Tesla and Meta (Facebook).
The “Magnificent 7” dominate not just the composition of the index but also the performance. Largely responsible for the S&P’s global outperformance over the last 10 years, in recent months the tide has turned for some tech stocks and during August, 50% of the market’s decline was attributable to just these seven shares. Apple alone accounted for 30% of the retreat. The effect of share price volatility in these stocks and value concentration has been felt in the broader index.
True, these international behemoths deserve their place in investors portfolios but Netflix, one of the original “FAANG”s, (Facebook, Apple, Amazon, Netflix, Google) has been replaced by Nvidia, the computer chip company, in a timely reminder that what goes up can come down. During Covid, while the world stayed at home watching telly, the price of Netflix more than doubled, only to come tumbling back by 75% when restrictions were relaxed.
Financial history is littered with similar stories. The original “Nifty Fifty” referred to a group of highly valued blue chip stocks popular in the 1960s and ‘70s and perceived as infallible. The market downturn of the 1970s dispelled the notion of their invincibility but serves as a cautionary tale for those who put too much faith in the record of past performance and the comfort of catchy acronyms. Markets, or at least those who opine on them, love a snappy moniker: the FAANGs, the Magnificent 7, the Nifty Fifty. “Blue Chip”, a byword for financial stability and good standing, ironically derives its name from the highest value gambling stake, blue traditionally being the colour of the largest casino chip.
While most acronyms relate to developed markets, the “BRICS” was coined by a Goldman Sachs economist to represent the developing economies of Brazil, Russia, India, China and South Africa. While the term has been used in countless sales promotions, the very disparate nature of these countries’ economic structures, political systems and growth trajectories has raised doubts about the cohesion of this grouping over and above the obvious marketing appeal of the phrase.
“We construct portfolios from old and new investments, traditional and alternatives positioned for the future rather than relying on what has been”.
There are multiple headline grabbing investment processes. Passive or index investing, over representing rapidly expanding growth sectors, putting greater store in duller but worthy “value” shares, momentum investing – buying those shares that are going up- or the inverse, contrarian investing-buying cheap bombed out underperformers. All these strategies work. Until they don’t.
Investment can be overcomplicated. So too can it be oversimplified. Whatever the approach, nuance and analysis is required. Whatever the goal Advanced Diversification still works.
With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. Past performance is not a guide to future performance. Tax rules can change at any time. This blog is not personal financial advice.
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