Diversification and Blending? You can’t make an apple and mango smoothie by blending apples with more apples
Key takeaways
Diversification requires more than simply blending active and passive funds
Combining active and passive investments may not provide true diversification if active funds hold many of the same stocks as passive indices or use tracker funds themselves.
Market concentration has increased investment risk
A small group of large technology companies, such as Nvidia, Apple, Microsoft and Amazon, have been responsible for much of the recent market performance, making broad indices less diversified than they may appear.
Investors should understand the underlying holdings in their portfolios
Looking "under the bonnet" is essential, as overlapping holdings across funds can lead to unintended concentration in the same stocks and greater exposure to specific risks.
Effective diversification comes from varied investment approaches and asset classes
W1M advocates a global, actively managed, direct investment approach combined with fixed income, real assets and alternative strategies to reduce concentration risk and improve long-term, risk-adjusted returns.
Market volatility reminds everyone that diversification matters. Blending active and passive funds is a common and sensible way of achieving a degree of diversification but blending different investment strategies may have less merit if passive funds are used in conjunction with active funds which are actually using trackers themselves or have the similarly large exposure to the largest companies in the world as passives.
If your active funds are heavily invested in Nvidia, Apple, Microsoft, Amazon, Alphabet, TSMC, Samsung, for example, and if those global technology “megacaps” are actually the names significantly driving performance, just as in a passive fund, is it worth blending? It may be an odd thing for an active manager to say but – why not just buy the index? The answer to that question would be all about how important it is to know what risks you are choosing to take.
The “AI trade” has enjoyed some spectacular performance in the last few years. Market concentration has become high (a few “megacap” technology stocks have been driving index levels owing to their size in indices); equity indices like the S&P500 got to record highs this year but with over 400 of the constituent stocks being down significantly; the index, therefore, was propelled higher by a relatively small number of names. Narrowness in markets got to extreme levels in October.
Narrowness of US equity market leadership is very unusual
Rolling 26-week correlation of price change in S&P500 and S&P500 Equal Weight indices
Source: Bloomberg, W1M. As at 30.10.26
Always kick the tyres and look under the bonnet…
If diversification is the intention, investors need to know what they are buying and blending and look under the bonnets of both active and passive solutions. The results can be surprising. The intended diversification from blending passive and active funds could be somewhat undermined if:
- Some active funds are heavily exposed to the same megacap technology stocks as passives and will move more in line with them as a result – on the way up and also on the way down;
- Some active funds use equity trackers so exposure to the index is not diversified but potentially magnified by blending;
- Some active “funds of funds” have multiple funds and no limit on those funds buying the same stocks; exposure to single stocks can be higher than people intend and dominate fund performance.
W1M portfolios have a “global, active, direct” approach to investing so our equity exposures are not based on funds of funds, which may duplicate holdings, but we tend to own fewer than 50 stocks and the resulting portfolio is not designed to track an index but deliver consistent, risk-adjusted returns above inflation over the medium to long run. Our equity portfolios are clearly not closet trackers. The table below shows the characteristics we favour relative when comparing our global Strategic Equity Fund and the MSCI World index. Our preference for high quality stocks with strong medium to long-term prospects is clear. Our portfolio has relatively strong sales and earnings growth with superior profitability. These characteristics do not guarantee superior performance in the shorter-term but in the longer run, we expect to meet, and have met, real return objectives without taking all the risk in indices.
The outcome of our equity investment process
Fund characteristics: higher growth, higher return with less financial leverage for a modest valuation premium
Source: MSCI, Factset, W1M. As at 30.09.26
Waverton Strategic Equity Fund data is the size-weighted average based on the fund’s holding. Protection Strategy and hedging is excluded from the analysis.
*Gross Margin, FCF Conversion, Net Debt/EBITDA and FCF Yield excludes banks and other financials (Interactive Brokers, SMFG, Capital One, Shinhan Financial, HDFC)
Risk warning: Past performance is no guarantee of future results and the value of such investments and their strategies may fall as well as rise.
Summary:
If blending investment strategies to achieve superior diversification, we think it makes sense if passive funds are blended with genuinely active funds aiming to do something more than match an index. We do not hold equity index funds but have a diversified, directly invested equity portfolio that is delivering double-digit real returns over the last 12 months but without taking on all the narrowness and concentration risk in markets. That can mean not getting all the upside in some periods but the other side of that is avoiding some downside in different periods. In addition to equities, we hold fixed income for diversification, and we design absolute return and protection strategies to mitigate volatility and give returns which are uncorrelated with equities. Real assets are included in our multi asset portfolios because investing, for example, in commodities, including gold, as well as property, power generation and infrastructure diversifies our multi asset solutions meaningfully as well as improving the inflation resilience in portfolios. Diversification across and within asset classes matters. Blending can be a great idea but you can’t make an apple and mango smoothie by blending apples with more apples.
Glossary
Diversification: The practice of spreading investments across different assets, sectors or strategies to reduce risk and avoid over-reliance on a single investment.
Passive Fund: An investment fund that aims to track the performance of a market index, such as the S&P 500 or MSCI World, rather than selecting investments actively.
Market Concentration: A situation where a small number of companies have a significant influence on the performance of a market index due to their large size and weighting.
Megacap Stocks: Very large companies with extremely high market values, such as Nvidia, Apple, Microsoft and Amazon, which can have a substantial impact on overall market returns.
Past performance is not a reliable indicator of future results. The value of investments and the income derived from them may rise as well as fall, and investors may not get back the amount originally invested. Capital security is not guaranteed.
This material is provided for informational purposes only and does not constitute investment advice or a recommendation. It should not be considered an offer to buy or sell any financial instrument or security. Any investment should be made based on a full understanding of the relevant documentation, including a private placement memorandum or offering documents where applicable. W1M Wealth Management Limited is authorised and regulated by both by the Financial Conduct Authority of 12 Endeavour Square, London E20 1JN, with firm reference number 120776 and the U.S. Securities and Exchange Commission of 100 F Street, NE Washington, DC 20549, with firm reference number 801-63787. Registered in England and Wales, Company Number 02080604.
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