Skip to content
Save
MarketScape · 07.25.23

Why Diversification Is at Risk

Inflation has driven up stock and bond correlations and fewer companies are influencing returns in equity indexes.
  • Markets & Economy
  • Market & Investment Trends
  • Market Views
  • Commentary
Deputy CIO & CIO of Global Equities
Key Points
Inflation Threatens Diversification’s Impact
Equity Concentration Adds to Risks
NASDAQ Rebalance

With the correlation between stocks and bonds near generational highs, equity risk likely has quietly become more prominent in your portfolio. To further complicate matters, the concentration of major equity benchmarks has increased dramatically in recent years. This may cause equity risk itself to rise, tied to a handful of mega-cap tech names. You may want to reconsider whether your portfolio is sufficiently diversified. Let’s take a closer look.

 

The correlation between stocks and bonds has spiked recently to levels not seen since the 1990s. This relationship is highly dependent on the time varying nature of inflation as both stocks and bonds respond similarly to inflation uncertainty and anticipated Fed reactions. With inflation at elevated levels, so too is the level of correlation. This means bonds probably won’t diversify equity risk as they once did. As a result, equity risk likely contributes more to your portfolio’s total risk than it did before.

 

But equity risk itself is changing. In the COVID and post-COVID era, the concentration of equity benchmarks has increased dramatically. In December of 2019, the top 10 names in the S&P 500 represented 23% of the index’s market cap. Today, that has grown to more than 30%, with most of these names representing higher-volatility, growth-oriented, tech and communication services stocks. In fact, the S&P 500 Index of today has as much growth exposure as a 50/50 blend of the S&P 500 and the Russell 1000 Growth Index did in December of 2019. Equity benchmarks worldwide are increasingly skewing toward very concentrated growth.

 

One example is the NASDAQ 100, where just seven names make up 55% of the market cap of the index. To combat this high level of concentration and risk from a small number of names, the NASDAQ 100 underwent a special rebalance last week to partially de-emphasize the largest tech mega-caps in favor of smaller companies such as consumer discretionary firms Starbucks and Mondalez International.  Between announcement date on July 14th and rebalance date, big tech names were down about 4%, highlighting the volatility created by attempts to fight concentration.

 

Equity markets may get choppier and you may not be as well diversified as you think. We think rising correlations and increasing concentration pose a serious threat to your portfolio.  We favor lower volatility equity strategies for this type of uncertain risk climate.

Main Point

Preparing for Potentially More Volatility

Equity markets may get choppier and you may not be as well diversified as you think. We think rising correlations and increasing concentration pose a serious threat to your portfolio. We favor lower volatility equity strategies for this type of uncertain risk climate.

MarketScape

  • Read Now
Teal marble rolling ahead of white blocks

Michael Hunstad, Ph.D.

Deputy Chief Investment Officer & Chief Investment Officer of Global Equities

Michael Hunstad is deputy chief investment officer and chief investment officer of global equities for Northern Trust Asset Management. Michael is a member of the Asset Management Executive Group and has oversight of all equity portfolio management, research and trading activities including quantitative, index and tax-advantaged strategies. Additionally, he assists with the development of investment vision, strategy portfolio construction and risk management framework for the firm’s broad investment platform.

Read Bio

Contact Us

Interested in learning more about our expertise and how we can help? 

IMPORTANT INFORMATION

For Asia-Pacific (APAC) and Europe, Middle East and Africa (EMEA) markets, this information is directed to institutional, professional and wholesale clients or investors only and should not be relied upon by retail clients or investors. The information contained herein is intended for use with current or prospective clients of Northern Trust Investments, Inc (NTI) or its affiliates. The information is not intended for distribution or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation. NTI or its affiliates may have positions in and may effect transactions in the markets, contracts and related investments different than described in this information. This information is obtained from sources believed to be reliable, its accuracy and completeness are not guaranteed, and is subject to change. Information does not constitute a recommendation of any investment strategy, is not intended as investment advice and does not take into account all the circumstances of each investor.

 

This report is provided for informational purposes only and is not intended to be, and should not be construed as, an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Recipients should not rely upon this information as a substitute for obtaining specific legal or tax advice from their own professional legal or tax advisors. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. Indices and trademarks are the property of their respective owners. Information is subject to change based on market or other conditions.

 

All securities investing and trading activities risk the loss of capital. Each portfolio is subject to substantial risks including market risks, strategy risks, advisor risk, and risks with respect to its investment in other structures. There can be no assurance that any portfolio investment objectives will be achieved, or that any investment will achieve profits or avoid incurring substantial losses. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Risk controls and models do not promise any level of performance or guarantee against loss of principal. Any discussion of risk management is intended to describe NTI or its affiliates’ efforts to monitor and manage risk but does not imply low risk.

 

Past performance is not a guarantee of future results. Performance returns and the principal value of an investment will fluctuate. Performance returns contained herein are subject to revision by NTI or its affiliates. Comparative indices shown are provided as an indication of the performance of a particular segment of the capital markets and/or alternative strategies in general. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index. Net performance returns are reduced by investment management fees and other expenses relating to the management of the account. Gross performance returns contained herein include reinvestment of dividends and other earnings, transaction costs, and all fees and expenses other than investment management fees, unless indicated otherwise. For additional information on fees, please refer to Part 2a of the Form ADV or consult an NTI representative.

 

Forward-looking statements and assumptions are NTI or its affiliates’ current estimates or expectations of future events or future results based upon proprietary research and should not be construed as an estimate or promise of results that a portfolio may achieve.  Actual results could differ materially from the results indicated by this information.

 

Hypothetical portfolio information provided does not represent results of an actual investment portfolio but reflects representative historical performance of the strategies, funds or accounts listed herein, which were selected with the benefit of hindsight. Hypothetical performance results do not reflect actual trading. No representation is being made that any portfolio will achieve a performance record similar to that shown. A hypothetical investment does not necessarily take into account the fees, risks, economic or market factors/conditions an investor might experience in actual trading. Hypothetical results may have under- or over-compensation for the impact, if any, of certain market factors such as lack of liquidity, economic or market factors/conditions. The investment returns of other clients may differ materially from the portfolio portrayed. There are numerous other factors related to the markets in general or to the implementation of any specific program that cannot be fully accounted for in the preparation of hypothetical performance results. The information is confidential and may not be duplicated in any form or disseminated without the prior consent of NTI or its affiliates.

 

This information is intended for purposes of NTI and/or its affiliates marketing as providers of the products and services described herein and not to provide any fiduciary investment advice within the meaning of Section 3(21) of the Employee Retirement Income Security Act of 1974, as amended (ERISA). NTI and/or its affiliates are not undertaking to provide impartial investment advice or give advice in a fiduciary capacity to the recipient of these materials, which are for marketing purposes and are not intended to serve as a primary basis for investment decisions. NTI and its affiliates receive fees and other compensation in connection with the products and services described herein as well as for custody, fund administration, transfer agent, investment operations outsourcing, and other services rendered to various proprietary and third-party investment products and firms that may be the subject of or become associated with the services described herein.

 

Northern Trust Asset Management is composed of Northern Trust Investments, Inc., Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K., NT Global Advisors, Inc., 50 South Capital Advisors, LLC, Northern Trust Asset Management Australia Pty Ltd, and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.

 

Not FDIC insured | May lose value | No bank guarantee