Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 398

You think you're passive but are you really concentrating?

As investing rules of thumb go, 'don’t put all your eggs in one basket' is widely accepted and uncontroversial. Sure, a lot of academic work has been done on the optimal number of baskets investors should have, what each basket should be made of, even the number of eggs to include in each, but the general principle is considered a sound way of spreading risk. And more baskets are better than fewer.

The problem with rules of thumb is that they can often oversimplify things. In average circumstances, simplification is usually enough, but right now, markets are anything but average.

There's more to diversification than 'more'

In the case of diversification, the difference between the rule of thumb and a more nuanced version lies in the gap between the expression more = better and more + different = better.

For a portfolio to be diversified it can’t just have lots of things in it, it needs to be filled with assets that are going to react in different ways to the same thing.

And, by that logic, we believe, the broad market is far less diversified right now than it looks on paper, especially if you are a passive investor.

Take the FTSE World Index, for example. Using the more = better version of diversification, an investment into an index that provides exposure to thousands of stocks across the globe should provide a good degree of diversification.

But, as is evident from the chart below, which plots the stocks in the FTSE World Index, with bigger positions shown as bigger yellow circles, the index is currently heavily weighted to defensive growth stocks (see the bottom right hand quadrant).

These include companies like Amazon and Netflix, with business models almost perfectly designed to benefit from the economic climate created by a global pandemic in 2020. Those conditions have propelled these 'lockdown beneficiaries' to rich valuations and to a colossal weight in the index. So much so, that defensive growth companies now account for over 40% of the index.

Under the microscope: FTSE World Index

As at 31 Dec 2020. Source: Various industry sources, Company information, Orbis. Statistics are compiled from an internal research database and are subject to subsequent revision due to changes in methodology or data cleaning. Stocks in the FTSE World Index are ranked based on their valuations (dividend yield, earnings yield, free cash flow yield and book to price; all based on trailing 12 month fundamentals) and their beta to a basket of global yields (as a proxy for cyclicality). Figures represent the aggregate weighting of shares within each quadrant for the FTSE World Index. Figures may not sum due to rounding. Bubbles representing the top three stocks in the FTSE World Index have been labelled.

Success creates sector bets

While there is no denying that many of the companies within the bottom right hand quadrant are of high quality, many are in similar sectors and are exposed to similar economic forces, which means they won’t necessarily do a good job of diversifying risk should economic circumstances or investor sentiment change.

To put an even finer point on it, in the US market (S&P500 Index), the top five stocks now account for almost a quarter of the total. That is a level of concentration never seen before. At the height of the technology bubble in 2000 the top five accounted for less than 20% of the total.

As at 31 Jan 2021. Source: Refinitiv, Orbis.

Again, that is not to say that those five companies are bad, far from it. But rather, it points out that for every dollar invested into the broad S&P500 Index, roughly 25 cents is going into five technology stocks, all of which are in direct competition with each other in one way or another.

And, while the weight of the FANGAM stocks get the headlines, the extreme concentration seen within indices currently is not limited to developed markets. In fact emerging markets are arguably even more concentrated.

Within the MSCI Emerging Markets Index, the top 10 stocks currently account for over 30% of the total, approximately double their weighting five years ago.

As at 31 Jan 2021. Source: Refinitiv, Orbis.

As long-term, active, fundamental investors, we are no strangers to concentrated portfolios, in fact we are a firm believer in their ability to deliver outsized returns over the long run.

But, we build them intentionally from the bottom up. As we look across global markets today, that intent seems to be lacking, replaced by a fear of missing out that is leaving a lot of eggs in one very small basket. A basket predicated on the notion that the future is going to look very similar to the recent past. And, what we have learned over the past 30 years, is that the only thing we can say for certain about the future is that it seldom looks like the past.

 

Shane Woldendorp, Investment Specialist, Orbis Investments, a sponsor of Firstlinks. This report contains general information only and not personal financial or investment advice. It does not take into account the specific investment objectives, financial situation or individual needs of any particular person.

For more articles and papers from Orbis, please click here.

 

RELATED ARTICLES

Investors might be paying too much for familiarity

The problem with concentrated funds

Diversification works?

banner

Most viewed in recent weeks

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

Maybe it’s time to consider taxing the family home

Australia could unlock smarter investment and greater equity by reforming housing tax concessions. Rethinking exemptions on the family home could benefit most Australians, especially renters and owners of modest homes.

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

The best way to get rich and retire early

This goes through the different options including shares, property and business ownership and declares a winner, as well as outlining the mindset needed to earn enough to never have to work again.

A perfect storm for housing affordability in Australia

Everyone has a theory as to why housing in Australia is so expensive. There are a lot of different factors at play, from skewed migration patterns to banking trends and housing's status as a national obsession.

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Latest Updates

Economy

The ‘priced out generation’ and what they should do about it

A fiery interview on housing exposed deep generational divides, sparking youth outrage and political backlash. As homeownership drifts out of reach, young Australians face a choice: fight the system - or redefine success.

Taxation

Maybe it’s time to consider taxing the family home

Australia could unlock smarter investment and greater equity by reforming housing tax concessions. Rethinking exemptions on the family home could benefit most Australians, especially renters and owners of modest homes.

Superannuation

Meg on SMSFs: Ageing and its financial challenges

Ageing SMSF members can face issues funding their pension income as cash reserves dwindle. Potential solutions include involving adult children in contributions to secure future financial stability.

Economy

US earnings season was almost too good to be true

The second quarter US earnings season has wrapped up, with a record 82% of S&P 500 firms beating earnings estimates. As tailwinds fade, Q3 may reveal whether AI momentum can offset rising economic headwinds. 

Gold

Does gold still deserve a place in a diversified portfolio?

9,000 years and no devaluations later, gold is the world’s most enduring store of value. It remains attractive as the value of several paper currencies, including the US dollar, are threatened by deficits and rising debt.

Shares

Checking in on the equity market's silent engine

Consumer spending directly impacts corporate earnings, sector performance and market sentiment. The latest data from different economies uncover risks and pockets of opportunity for investors.

Fixed interest

6 key themes driving bond markets

The Fed could soon be prompted to join other central banks in cutting interest rates. This would have ripple effects across global fixed income markets and provide an especially attractive backdrop for emerging market bonds.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.