More than one bas­ket

The main in­vest­ment mar­kets are over­crowded, so it’s time to di­ver­sify

The Daily Telegraph - Business - - Front Page - Tom Steven­son

Ihave spent an aw­ful lot of the past 30 years say­ing ba­si­cally two things – don’t try to time the mar­ket and be well-di­ver­si­fied. Both of th­ese in­vest­ment mantras are in­ter­est­ing in part be­cause it is so easy to make a su­per­fi­cially at­trac­tive case against them. The first part of the counter ar­gu­ment is that buy­ing low and sell­ing high can make you a lot more money than timidly drip­ping your money into the mar­ket on a reg­u­lar sys­tem­atic ba­sis. The Nas­daq in­dex is up more than 60pc since March. Why would you not try to time that rally? The sec­ond part of the case against is that if you can buy just the best-per­form­ing stock, sec­tor, or mar­ket, you’ll be bet­ter off than if you care­fully place your eggs in a va­ri­ety of bas­kets. Over the past six months, Tesla has more than dou­bled while the US mar­ket as a whole has just re­turned to where it started. Pick­ing the win­ner has done twice as well as spread­ing your bets.

The trou­ble is, of course, that do­ing ei­ther of th­ese things con­sis­tently is im­pos­si­ble, which is why pru­dent in­vestors opt for the safer, if ul­ti­mately a bit dull, ap­proach of in­vest­ing reg­u­larly and sys­tem­at­i­cally into a bal­anced port­fo­lio.

The re­cent past has rather rubbed it in that sen­si­ble in­vestors pay a price for erring on the side of cau­tion, es­pe­cially when it comes to di­ver­si­fi­ca­tion. As Ap­ple’s mar­ket value burst through $2 tril­lion (£1.5 tril­lion) last week, it was widely ob­served that the top five stocks in the S&P 500 in­dex have ac­counted for 25pc of all the gains in the mar­ket since the March bot­tom. Not own­ing th­ese shares will have more or less guar­an­teed that you have fallen be­hind the US mar­ket as a whole. The dif­fer­ence be­tween be­ing an in­vest­ment genius and a fund man­age­ment fail­ure has es­sen­tially boiled down to one de­ci­sion.

Ap­ple, Ama­zon, Al­pha­bet, Mi­crosoft and Face­book now ac­count for more than one fifth of the to­tal value of the US bench­mark in­dex. Just a year and a half ago, this hand­ful of tech giants rep­re­sented less than 15pc of the S&P’s to­tal cap­i­tal­i­sa­tion; to­day it is 22pc. This is a big­ger slice of the whole for the top five shares than at any time

‘His­tory has not been kind to late ar­rivals in over-con­cen­trated mar­kets like this one’

since at least 1980, and even more than dur­ing the dot­com bub­ble when tech stocks last dom­i­nated to this ex­tent.

At times like th­ese, in­vest­ment seems sim­ple to many peo­ple who had not given it a great deal of thought un­til they no­ticed their friends and fam­ily mak­ing ap­par­ently easy money. This is pre­cisely the time that tried and tested mantras like the ones on tim­ing and di­ver­si­fi­ca­tion get ig­nored. And it is pre­cisely the time when they are most valu­able. His­tory has not been kind to late ar­rivals in over­con­cen­trated mar­kets like this one. The bear mar­ket of 2000 to 2002 that fol­lowed the burst­ing of the dot­com bub­ble saw shares fall at a com­pound rate of 14.6pc a year for three years. In­ter­est­ingly, you could have avoided much of this pain by hold­ing a di­ver­si­fied port­fo­lio. While big tech stocks were col­laps­ing, smaller value shares de­liv­ered a com­pound an­nual re­turn of 12.2pc. In 2008, when US shares fell by 37pc, US Trea­sury bonds rose by 26pc, al­though the value of di­ver­si­fi­ca­tion by as­set class has been less ob­vi­ous re­cently in the lat­est “bull mar­ket of every­thing”.

The trans­for­ma­tion of the S&P 500 into a bet on the con­tin­ued dom­i­nance of Sil­i­con Val­ley is a re­minder that there is more to di­ver­si­fi­ca­tion than sim­ply buy­ing an in­dex tracker fund. We have known this for a long time here in the UK, where it is recog­nised that the FTSE 100 is not just a poor re­flec­tion of the UK econ­omy but a very nar­row proxy even for the stock mar­ket. Strip out one bank (HSBC), and the top 10 com­pa­nies in the UK bench­mark come from just three sec­tors: phar­ma­ceu­ti­cals, ex­trac­tive in­dus­tries (oil and mining) and con­sumer staples.

As­traZeneca and GSK alone ac­count for 12pc of the value of the FTSE 100. Just as they do in Amer­ica, the top five stocks in the UK mar­ket rep­re­sent more than one fifth of the to­tal value of the bench­mark. In some smaller stock mar­kets, the con­cen­tra­tion is even more strik­ing. When Nokia was a force to be reck­oned with, it dom­i­nated the Fin­nish stock mar­ket. Even in the much bet­ter di­ver­si­fied Ger­man mar­ket to­day, SAP, Linde and Siemens ac­count for more than one third of the DAX 30’s to­tal value.

So, di­ver­si­fi­ca­tion by ge­og­ra­phy mat­ters, but pos­si­bly not in the way that we thought. In­vest­ing in a va­ri­ety of stock mar­kets around the world may not nec­es­sar­ily pro­vide you with an ex­po­sure to a range of dif­fer­ent economies but, thanks to the in­creas­ing bias of some mar­kets to just a hand­ful of in­dus­tries, it could pro­vide use­ful sec­tor di­ver­si­fi­ca­tion. In­vest­ing in Ja­pan and Ger­many gives ex­po­sure to global man­u­fac­tur­ing, the UK to pharma and mining and the US to tech­nol­ogy.

Two other forms of di­ver­si­fi­ca­tion may be worth a look. Size is from time to time a sig­nif­i­cant dif­fer­en­tia­tor. In the late Nineties, big was beau­ti­ful and this time around, too, it has been an ad­van­tage. If you had in­vested $100 five years ago in the S&P 500 in­dex, it would be worth $166 to­day. The same $100 in the Rus­sell 2000 smaller com­pany in­dex would be worth just $133. If the big tech stocks fal­ter, that dif­fer­ence is likely to nar­row. The other fea­ture of a well-di­ver­si­fied port­fo­lio is a range of in­vest­ment styles. A shared char­ac­ter­is­tic of the best-per­form­ing stocks in re­cent years has been their abil­ity to de­liver con­sis­tent earn­ings growth. At­trac­tive val­u­a­tions have been much less im­por­tant. But styles come and go. The time to di­ver­sify is when no one thinks it is worth both­er­ing.

Tech­nol­ogy stocks have pushed Wall Street to record highs, but tried and tested in­vest­ment mantras should not be ig­nored

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