Why investors need diversification now more than ever

If ever investors needed diversification, it is now. Stock markets have become increasingly concentrated in the US, and in a handful of technology stocks, just as the US is in the grip of an unpredictable new regime. US stock markets have sold off since the start of the year, while other markets around the globe have started to command more investor attention. There are real opportunities for those who want to introduce more diversification into their ISA. 

Precious metals

The gold price has been one of the clear investment success stories of the past year, rising 33%*. It has been a bulwark against geopolitical uncertainty, and the fears around tariffs, even though real yields and the dollar have remained high – usually a more difficult environment for the gold price. 

In normal circumstances, investors would expect gold miners to outpace the gold price. This hasn’t happened in this cycle. Partly, investors have been distracted by the charms of the US technology sector, but the companies themselves have also been weakened by higher inflation, which has raised input costs. 

Ned Naylor-Leyland, manager on the Jupiter Gold & Silver fund, believes this leaves a window for gold mining companies to catch up. He points out that margins are improving, costs – including energy prices – are drifting lower, while the factors keeping the gold price high remain in place. He also believes that gold provides “plenty of hedging and insurance characteristics”.

He says there are also plenty of opportunities in the silver market: “Silver is used in everything – from solar panels to electric cars to healthcare to missiles. There is a chronic supply/demand imbalance in silver. There hasn’t been any real increase in supply as demand has risen.” 

Infrastructure & real assets

While equity markets have been soaring, areas such as property and infrastructure have lagged the wider market. Partly this is a function of interest rate expectations. Income-generative areas such as property and infrastructure tend to do well when interest rates are falling, and the slower pace of anticipated interest rate cuts has hurt performance. 

Nevertheless, these areas tend to be more defensive when markets hit a rough patch. They have relatively predictable cash flows, which adjust with inflation. Demand for infrastructure assets such as toll roads, schools, or utilities does not usually vary with the economic cycle. 

Nick Langley, manager on the FTF ClearBridge Global Infrastructure Income fund, says uncertainty surrounding Trump policies will affect both the economic and market outlook for the year, but adds, “We have the ability within our portfolios to tilt toward more defensive positioning through our exposures to regulated and contracted utilities, or to take on some more economic sensitivity through exposure to GDP growth and the business cycle, through energy infrastructure, airports, rail and toll roads, for example. Today we are tilted somewhat defensively.”

Nick sees particular strength in the utilities sector, where valuations are attractive and growth looks strong, driven by AI data centre power demand, industry decarbonisation and resiliency spending. 

Real assets – which include property and infrastructure, but also add in areas such as natural resources and commodities – also proved their worth in the last downturn in 2022, when bond and equity markets sold off concurrently. The Cohen & Steers Diversified Real Assets fund is a good pick in this area. 

Anywhere but the US

Almost any global fund has a chunky weighting in the US market. This is particularly extreme for index funds: the MSCI World, for example, has 73% of its market capitalisation in the US**. Alliance Witan recently pointed out that the index on average allocated around 150 times as much capital to each of Apple, NVIDIA and Microsoft as it did to the average stock***. That said, the problem also applies to many active global funds. The US has absorbed almost all the attention of global investors in recent years. 

There have been rational reasons for this. The earnings growth of the mega-cap stocks has significantly outpaced that of the rest of the market. Lipper Alpha data shows that the Mag 7 companies (Apple, Alphabet, Amazon, Nvidia, Meta, Microsoft and Tesla) contributed 52% of total net earnings growth in 2024****. 

However, this is changing. Not only is the earnings growth gap with the rest of the US market narrowing, it is also narrowing with the rest of the world. In particular, earnings upgrades for European companies are outpacing those for the US^.

Rob Burnett, manager of the WS Lightman European fund, sees a brighter future for European equities: “Trump’s own economic nationalism is likely to push Europe and China to support their own economic growth more forcefully. In this way, Trump might help markets in other parts of the world. Europe, in particular, has willingly pursued energy and regulatory policies that have stifled growth. This may begin to change in 2025, led by Merz in Germany.

“We would expect European equities to outperform the US in 2025. Expectations, valuations and positioning suggest the US has a high hurdle to overcome. Europe in contrast has low expectations, low valuations and low allocations.”

Smaller companies 

Investors have only had eyes for the index heavyweights in recent years, leaving small-caps largely neglected. The valuation gap now looks extreme. As Alex Magni, manager on the Montanaro European Income fund, says: “The Q4 earnings season has already started strongly, setting a solid foundation for the year. Valuations remain at extreme discounts compared to LargeCap, more extreme even than the gap reached during the Global Financial Crisis of 2008.” 

Earnings are improving, M&A is reviving, and interest rates are coming down in Europe and the UK. This should be a favourable backdrop for smaller companies. Equally, much of the weakness for smaller companies has been sentiment-driven, and doesn’t reflect the reality on the ground. 

Scott McKenzie, manager on the WS Amati UK Listed Smaller Companies fund, says: “It is telling that UK stock market news is still dominated by two themes: takeover activity and share buybacks. That trade buyers see value in UK listed companies and that the management teams of these companies judge the best return on capital comes via retiring their own shares, are both strong signals that the UK market continues to offer compelling value.”

There is plenty of growth out there and now the US technology giants are having a wobble, there is even more motivation to look for it. 

*Source: goldprice.org, 10 March 2025

**Source: index factsheet, 28 February 2025

***Source: London Stock Exchange, Alliance Witan final results, 7 March 2025

****Source: LSEG, 7 March 2025

^Source: CNBC, 18 February 2025