As legendary investor Ray Dalio once put it “diversification is the holy grail of investing”.
Imagine this: Apple, Microsoft, Amazon, Nvidia, Meta, and Tesla. Six giants dominate 37.54% of the NASDAQ index and 23.65% of the S&P 500 index.
If you are invested in both indices, they could make up over 61% of your investment portfolio. Incredible, right?
But, does this not violate the promise of diversification inherent in index investing?
Take Apple, for instance, valued at around £2.23 trillion. The problem is that the number is so large it can seem abstract.
To put that into perspective the total value of the one hundred companies in the FTSE 100 is about £2.003 trillion and the UK economy is £2.2 trillion.
It’s like Apple’s worth is equal to the entire market capitalisation of the top 100 UK firms – the UK economy itself, a heavyweight on the global stage.
It’s also equivalent to the UK economy which is one of the sixth-biggest economies in the world.
If you add Microsoft, Amazon, Nvidia, Meta, and Tesla that will be around £7.40 trillion in market capitalisation in total.
That’s equivalent to the economies of the UK, India, France, Italy, and Canada. Those countries ranked from 5th to the 9th biggest economies in the world.
The big five tech companies Apple, Amazon, Google, Meta, and Microsoft generated around $900 billion in revenue in 2020, compared to the Netherlands economy’s $909 billion.
That’s impressive but don’t you think the law of large numbers will adversely affect their growth?
According to Ray Dalio, diversifying your investments among 10-15 uncorrelated asset classes can reduce your risk by as much as 80% without reducing returns.
However, Warren Buffet disagrees. Let’s find out why.
The Clash of Titans: Diversification vs. Concentration
When two investing giants disagree, it’s a topic worth discussing. Ray Dalio champions diversification across uncorrelated assets, while Warren Buffet leans into his core holdings.
Perhaps you think like Warren Buffett who contrary to the conventional wisdom, suggests that diversification is actually protection against ignorance. It makes little sense if you know what you are doing.
For instance, dive into Warren Buffet’s portfolio and you’ll find Apple seizing a hefty 46.44%.
And the top 5 holdings Apple, Bank of America, American Express, Coca Cola and Chevron make up 77.5% of his portfolio.
You might think that’s a highly concentrated portfolio.
Buffet knows these businesses well and prefers owning them over a larger quantity of unfamiliar companies.
Consider a scenario where you sell your business for one million and want to invest it.
Would you scatter your money, £10,000 each among 100 companies, or identify the best businesses and invest in quality businesses led by competent management?
As long as they remain good companies, Buffet believes you should follow the latter approach.
We all agree technology companies have been the dominant driver of economic growth in recent years, transforming the way we communicate, shop, socialise, and work, and they will continue to do so.
Their impact is undeniable. But a burning question looms – will these tech giants persist over the next two decades?
Capitalism is a ruthless game if those companies do not evolve there is no guarantee they will be around.
So, reconsider your approach to concentration risk. Diversifying across uncorrelated asset classes safeguards your investments and ensures your long-term success in a rapidly evolving financial landscape.
Awet Ghirmay, Head of Investment Research
If you’re interested in learning more about this topic, please find the link here.
More information about the fund can be found here: Hargreaves Lansdown or AJ Bell
Risk warnings
*The value of investments and the income derived from them may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs practice. Levels and bases of tax relief are subject to change. This blog is based on my own observations and opinions.
