As the end of the tax year approaches, many investors are reviewing their portfolios and considering how best to maximise their ISA allowances. While the temptation to stick with past winners like US equities may be strong, growing concerns over a potential US recession and the recent underperformance of the S&P 500 highlights the significant risks of overexposure to a single market, says Fidelity International, as they make clear in the following analysis:
In recent years, the US market has been driven by a handful of technology stocks, creating a market heavily reliant on a single sector. But as market conditions have shifted and with increasing geopolitical uncertainties, cracks in the dominance of US equities are becoming apparent.
Many investors may not even realise they are heavily concentrated in the US. With global indices like the MSCI World weighted heavily towards US equities, particularly large-cap tech stocks, portfolios that track benchmarks often carry significant exposure to one region. This unconscious concentration increases vulnerability in market downturns and limits participation in growth opportunities outside the US.
Fidelity International (“Fidelity”) highlights how diversification – spreading investments across regions and asset classes – is a crucial strategy to building resilience and managing risk.
The case for diversification
Fidelity examined the performance of two investment strategies over five, 15 and 20 years, comparing a concentrated approach – investing £20,000 in a single asset class, with a diversified portfolio – splitting that £20,000 and allocating £1,333 to 15 different asset classes.
Historical performance highlights the challenges of predicting which asset class will lead in the future. For example, over a 20-year period, US equities delivered outstanding growth, turning £20,000 into £229,484, while commodities underperformed, returning just £29,400. The range of returns is large – and unforeseeable at the time of investment.
The diversified portfolio achieved £89,995 over the same period. Although it was outperformed by some individual asset classes, notably US and global shares, it offered stability, beating nine out of the 15 analysed asset classes, including cash (£30,071) and government bonds (£39,009). This consistency underscores how diversification can protect against underperformance, while still participating in growth opportunities. Meanwhile, focusing solely on recent top-performers exposes investors to significant risks if markets shift.
Asset class performance over the past 20 years:
Source: Datastream, January 2025. Investing £1,333 in 15 different asset classes- total returns in GBP from 31.01.05 – 31.01.25
Over a 15-year period, Japanese equities (£64,329) and real estate (£67,313) outperformed the diversified portfolio (£62,143). Yet these gains were cyclical, with Japanese equities underperforming over 20 years (£76,282 vs £89,995) revealing the unpredictable nature of markets and the risks of relying too heavily on individual asset classes.
Asset class performance over the past 15 years:
Source: Datastream, January 2025. Investing £1,333 in 15 different asset classes- total returns in GBP from 31.01.10 – 31.01.25
In the shorter five-year timeframe, the benefits of diversification remain evident. Commodities performed well, with returns of £33,028, but their longer-term performance lagged significantly, and they were the one of the worst-performing asset class over 15 years (£24,706 vs £62,143) and 20 years (£29,400 vs £89,995).
Asset class performance over the past 5 years:
Source: Datastream, January 2025. Investing £1,333 in 15 different asset classes- total returns in GBP from 31.01.20 – 31.01.25
Tom Stevenson, Investment Director, Fidelity International, comments: “Would investors have been better off simply putting all their money into US equities? In hindsight, yes. But to have done so 20 years ago would have required the kind of foresight that investors do not enjoy. The longer I study financial markets, the more I understand how little we really know about the future. As investors, we don’t have a crystal ball – we don’t know what’s going to happen and we don’t know how investors will react to what does unfold.
“Take the last five years as an example: we’ve experienced a pandemic, wars in Europe and the Middle East, the worst inflationary spike since the 1970s and a dramatic rise in interest rates after a prolonged period of cheap money. Despite all this, US equity investors have been handsomely rewarded thanks to the dominance of technology companies and the market’s recent love affair with AI. However, recent developments – including the underperformance of the S&P 500 and growing fears of a US recession – are a stark reminder that no market dominance lasts forever.
“Our analysis reveals that over five, 15 and 20 years, US equities have consistently outperformed a diversified portfolio. However, valuations in the US today are relatively expensive and returns have been driven by a small handful of stocks, meaning the S&P 500 index comes with a high degree of sector risk.
“Will US equities outperform for the next five, 15 and 20 years? And, in particular, will the US market continue to be dominated by a small handful of large technology stocks? No-one knows; the future is uncertain. Faced with this uncertainty, what can we do? First, we can avoid making big bets on regions, sectors, or asset classes. Yes, we can kid ourselves we saw the winners ahead of time. More likely, we got lucky. The cure for the absence of foresight is diversification. We can’t always anticipate the next big trend, and that’s why spreading investments across a range of asset classes provides resilience, balances risk and ensures we’re not overly reliant on a single sector or theme.
“As we approach the tax year-end, now is the perfect time to review your portfolio and ensure your investments are working towards your long-term goals. A diversified ISA not only mitigates risk but helps you stay resilient through market cycles, allowing you to be invested confidently in what matters most.”
Tom Stevenson outlines three investment options from Fidelity’s Select 50 for investors to consider when building a diversified ISA portfolio:
Dodge & Cox Worldwide Global Stock Fund
“Dodge & Cox Worldwide Global Stock is a core international equity fund that invests in the developed and emerging markets. The managers aim to build a diversified portfolio of medium-to-large, well-established companies that appear to be temporarily undervalued, but have a favourable outlook for long-term growth. The company has substantial research resources, the management team is experienced, and they have worked together a long time. That’s important when building a high conviction fund with long holding periods.”
Brown Advisory US Smaller Companies Fund
“Brown Advisory US Smaller Companies is a good choice for an investor that wishes to retain an exposure to the US stock market but is concerned about a rotation away from the Magnificent Seven technology stocks. The US is a rich hunting ground for the innovative, high quality smaller companies that have the potential to grow into tomorrow’s corporate giants. This fund has a clearly articulated quality-growth approach that builds a fairly concentrated portfolio of small and mid-cap stocks. It looks for well-governed companies, with durable growth prospects that can scale up in the near future and it looks to hold them for long periods to outlast other less patient investors.”
“The Fidelity Global Dividend offers a sensible diversification from the US stock market, not just in terms of geography but also investment style. Dan Roberts has run this fund since 2012 and has delivered strong absolute and risk-adjusted returns despite an underweight to the US market. He manages a low turnover, high conviction portfolio with a focus on income, attractive valuations and visibility of returns. He looks for a margin of safety and the ability for shares to re-rate. He has a bias towards traditional defensive sectors such as consumer staples, pharmaceuticals and healthcare and limited exposure to more cyclical areas like basic materials and retail.”
Fidelity’s principles for good investing, including diversification, provide a solid framework to help investors navigate market challenges and achieve their long-term financial goals. The Select 50 and Navigator tools provide investors with a curated list of top investment options and assist investors in making investment choices based on features that are important to them, helping them make informed decisions and effectively diversify their investments.
