Is your global equity exposure truly diversified?

Watching the Tour de France unfold last summer was hugely enjoyable with two well-matched adversaries for the Yellow Jersey, Slovenia’s Tadej Pogacar and Jonas Vingegaard from Denmark. Typically, the race favourites spend much of their time in the ‘peloton’, the mass of riders that hurtles across the French countryside, aerodynamically protecting one another to save energy for the crucial culmination of each stage.

Those that decide to initially set off at faster pace in search of a win do sometimes escape to victory, but usually the odds are against them as the pace of the peloton ratchets up and they are reined in. Ultimately, the winner often comes from the pack that has had an easy ride for much of the day.

There is a useful investing analogy here. Taking extra risks to try and outpace market returns can sometimes pay off, but being in a ’peloton’ of broad market investments can more effortlessly get you a long way without the risk that you get things terribly wrong and you fall significantly behind. It’s why investors who prioritise diverse, low-cost passive investments for the core of their portfolio often enjoy good results without huge effort. Such investments simply follow the market index rather than attempt to beat it.

But just as the specialist cyclists seeking stage victories can get their timing right and claim glory, an active and selective investment approach can sometimes win the day. Opportunistic investors, or those willing to take a contrarian approach, can put distance between themselves and others. There are also occasions when the peloton idles along or, more damagingly, falters from an accident in the pack. Those taking a differentiated approach can then capitalise.

What are the risks of a concentrated market?

Could we be due a phase in markets where the free thinkers have a better chance of coming to the fore? In recent years riding in the peloton of broad stock market indices via a global tracker has been the perfect strategy. Some of the world’s largest companies, the so-called Magnificent Seven tech-enabled businesses including Microsoft, Apple and Nvidia, have overshadowed virtually everything else. And it’s resulted in an astonishingly top-heavy market.

Amazingly these seven top dog US stocks are valued almost as much as the next seven biggest countries combined as the graphic below illustrates:

Chart: Weights of top stocks and countries (ex-US) in MSCI ACWI, (%)

Traditional passive global investors are therefore increasingly reliant on a relatively small number of businesses continuing to deliver. There is a risk the pace of the market peloton becomes pedestrian going forward if these race favourites disappoint.

The high valuations of these stocks, combined with their size in the US and global market indices, is therefore pause for thought, and perhaps some concern. True, they offer good growth potential, and they could be prime beneficiaries from advances in AI, a narrative that has captured investors’ imaginations.

Yet these companies also appear to be expensively valued in relation to their earnings, so they could also be more vulnerable to any disappointing news surrounding their profitability or outlook. We have witnessed this recently with the announcement from China’s DeepSeek that it had trained a generative AI model at a fraction of the cost and time expended by the market leaders.

The impact of DeepSeek’s innovation is yet to be fully understood, so this may not be a moment where the wheels come off the AI investment bandwagon. Indeed, the second-order impacts may be beneficial in terms of accelerating the adoption of AI technology through lower costs. However, it does underline that little is ever certain in investing, and that markets are vulnerable to stumbles from the dominant US mega cap stocks or from greater competition. It’s a reminder of the need to build resilient portfolios that aren’t simply ‘flying on one engine’.

How can I invest globally but have less exposure to the Magnificent Seven and big US tech?

US and global equity indices do not offer the diversification they once did. For index investors targeting only cheap global passive funds the large exposure to just a handful of companies could ultimately undermine investment goals. It is therefore worth considering further diversification through less expensive markets, value-oriented funds or actively managed strategies.

Rather than blindly buy the index, active managers take a sniper’s approach of targeting what they feel offers best value for the promised growth. They are also free to roam across global markets as they see fit and don’t necessarily have to allocate a majority to the dominant US market.

We can’t be sure that any one strategy will offer investors the opportunity of a podium finish in the next market stage. But when the market peloton has been pulled along for so long by such a small band of riders doing most of the work, they do stand to offer something different.

With so many options available it’s not easy to pick out a global fund, but there are a couple of options among the funds detailed in our recent article: Six investment ideas for your 2024/25 ISA allowance.

If you are not convinced by the approach of a particular active manager, you could consider an ‘equally weighted’ passive fund based around a popular index such as the US S&P 500 or the global MSCI World. Instead of weighting each company in the index according to its size, which is the traditional way of doing things, each constituent is given the same weight.

Using the S&P 500 index, for example, each company is just 0.2% of the fund. This means if there is a broader set of winners in the market going forward, then the approach stands to capitalise. Plus, it prevents overexposure to the tech heavyweights for investors concerned that they have come to represent too much of their portfolio.