PA & Orbis present: PA360 Watchlist

MAY 2025

New approaches to resilient portfolios

In this Watchlist...

Recent events have highlighted the importance of genuine diversification in a concentrated market

n a world of highly concentrated markets, still-high inflation and heightened correlations, genuine diversification is harder to achieve. The US – and a handful of tech giants – have

However, such concentrated capital raises two crucial questions: Are investors focusing their attention in the wrong area? And how to diversify in a concentrated market?

In our exclusive PA 360 Watchlist, Orbis Investments examine the challenges of achieving true diversification in a market dominated by a handful of stocks – and why opportunities still exist for those who look beyond the obvious. Explore:

• How market concentration around a few mega-cap stocks is reshaping portfolio risks • Why blending active and passive strategies can help investors build smarter resilience • Why genuine diversification is essential – and harder to achieve – in today’s market • If investors could be looking behind the wrong door

Redefining diversification in a concentrated market

The Monty Hall Market: three lessons for today's investors

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PA360 WATCHLIST

odel portfolio services are projected to grow to £154bn by 2028 and their increasing popularity reflects their importance for financial advisors and their practices.

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dominated equity markets for years, powering a disproportionate share of returns and capturing investors' attention. Today, the outsized influence of the so-called "Magnificent Seven" on global indices is undeniable.

In today’s environment of concentrated markets, persistent inflation, and heightened correlations, achieving genuine diversification is more challenging than ever. However, it’s far from impossible.

The so-called “Magnificent Seven” account for a staggering slice of global indices. But when so much capital and consensus are crowded in the same place, it’s worth asking: are investors looking behind the wrong door?

Yet, their performance often lags behind developed markets like the S&P 500. This may stem from a common misconception: viewing GEMs as a monolithic asset class, rather than recognizing the diverse opportunities available to active investors.

However, such concentrated capital raises a crucial question: Are investors focusing their attention in the wrong area and how to diversify in a concentrated market?

• Why investors should consider blending active and passive strategies • How to create portfolios that are more resilient and better balanced

Capital at risk.

Capital at risk. Approved for issue in the United Kingdom by Orbis Investments (U.K.) Limited, which is authorised and regulated by the Financial Conduct Authority. Orbis Investments (U.K.) Limited is incorporated in England & Wales under company number 8138002. Registered office address: 28 Dorset Square, London, NW1 6QG. The information provided in this document is for general informational purposes only and does not constitute financial, investment, or other professional advice. The content is not tailored to the specific investment objectives, financial situation, or needs of any individual. Investors should not rely solely on this information in making investment decisions. We do not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from the use of or reliance on such information.

Subsequent peak-to-trough decline

One approach is to blend passive and active strategies. Unlike their counterparts, active strategies can navigate challenging environments with intent, lending passive portfolios an extra degree of resilience. Passive strategies are inherently vulnerable to turns in sentiment, when they are obliged to sell in lockstep. But active strategies are not forced to sell in the same way. Active managers can buy on conviction when stock prices fall – rather than selling on weakness as market-cap-weighted passive strategies inevitably do.

First, markets are more concentrated than ever. While markets have performed well over the past decade, most of the gains have come from a handful of stocks. As a result, indices – and subsequently passive strategies – are now heavily reliant on a small number of mega-cap technology stocks. For example, the top 10 stocks in the S&P 500 index made up 33.6% of the total index as of the end of March . This poses a clear risk for passive investors.

Why rising concentration and soaring valuations spell trouble

or years, the debate around active versus passive investing has raged on. And over the past decade, passive strategies have gained popularity thanks to their simplicity, low costs, and

Redefining diversification in a concentrated market

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strong performance as markets have climbed to record highs. While, for some, this performance has strengthened the case against active investing, it is also a double-edged sword. Markets, like tides, are constantly shifting – as highlighted by recent moves resulting from President Trump’s trade tariff announcements. Active strategies navigate these shifts with intent, while passive portfolios are bound to the current – leaving them vulnerable to choppier waters. As a result of the changing environment, we believe the next decade could be very challenging for those invested solely in passive and/or traditional strategies unless they adjust their portfolios.

So, what’s clouding the once-clear waters of passive investing?

As seen in the immediate aftermath of the introduction of Trump’s tariffs, should the fortunes of these mega-cap stocks reverse, passive portfolios could face significant headwinds.

Second, valuations – particularly in the US – have been circling historic highs, driven by near-record profit margins and expectations of robust earnings growth. This leaves markets highly vulnerable to a reversal, as even slight disappointments in earnings could trigger sharp declines. Typically, when prices are high, expectations are high, and when expectations are high, so is risk.

Blending active and passive

That’s not to say that passive strategies have no place in a portfolio. This is not a zero-sum game; passive has advantages over active when it comes to cost and convenience, and passive strategies can be used as an efficient means of achieving core exposures. Moreover, the performance of passive and active strategies tends to run in cycles, with one approach outperforming the other for some time before the ascendancy reverses .

Source: LSEG Datastream, Bloomberg, 31 Dec 2024. Uses monthly data. Gold: Gold Bullion LBM (USD per troy ounce). FANGAM Index: a market capitalisation weighted total return index of Facebook (Meta, Apple, Netflix, Google (Alphabet), Amazon and Microsoft. For each series data is shown from the start of decade to the peak and for ten years (when available) after the peak.

Sources: 1. spglobal.com 2. hartfordfunds

“Areas of the market that have delivered the best returns over the past 10 years are unlikely to repeat that stellar performance”

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And there’s another issue – when the market turns, history tells us that the most expensive areas tend to fall the fastest and furthest (see table below). Even without the current turmoil in markets, we think that the areas of the market that have delivered the best returns over the past 10 years are unlikely to repeat that stellar performance. Instead, we see much more significant downside risk. So, what can passive investors do to balance their portfolios?

But a combination of active stockpicking and passive core holdings can provide a crucial balance that helps investors to steer their way through challenging and polarised market environments. But that’s just one layer…

When they look beyond passive indices, investors should also be thinking about funds and strategies that stand out from the herd and complement their existing holdings/exposure. That way, they can aim to achieve diversification across both investment style and asset class. Funds with a distinctive investment approach are less likely to be correlated with generic passive approaches, and investors should ensure that their managers are taking a genuinely active approach rather than tightly hugging indices with just a nominal active share.

Is the active portion truly diversified?

The same goes for regional exposures and underlying holdings. While gains have been concentrated in a handful of stocks – leaving limited opportunities for broader outperformance – this also creates an opportunity for active investors who are willing to take the road less travelled.

By adding an active manager who zigs when their passive portfolio zags, investors can reduce the risk and volatility within their overall portfolio.

In a world of highly concentrated markets, still-high inflation and heightened correlations, diversification is harder to come by. But achieving appropriate diversification is by no means impossible. By blending active and passive strategies and seeking out opportunities with low correlations to the broad markets and their existing holdings, investors can create portfolios that are more resilient and better balanced – leaving them well positioned to navigate the choppy waters more smoothly.

Gold (30/09/80 - 28/02/85)

TOPIX (29/12/89 - 30/09/98)

NASDAQ (29/02/02 - 30/09/02)

MSCI World Materials (30/05/08 - 27/02/09)

-57%

-59%

-75%

-61%

-75%

NASDAQ (29/02/02 - 30/09/02)

-61%

MSCI World Materials (30/05/08 - 27/02/09)

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The puzzle is a compelling metaphor for today’s markets: just because something feels obvious – or has worked recently – that doesn’t make it the right choice in future.

nter the Monty Hall problem. This classic probability puzzle, loosely based on a 1970s game show, involves a contestant picking one of three doors – behind one is a car, behind the

On the surface, staying heavily invested in US equities looks sensible. It’s the world’s largest economy, home to dominant companies, and it has outperformed for over a decade. But history reminds us that market leadership shifts. In the late 1980s, Japan made up more than 40% of the global index – before its bubble burst. Similarly, the dot-com crash of 2000 exposed the perils of speculative excess in the technology, media and telecoms sectors. Both events were obvious in hindsight, but herd mentality and a fear of missing out clouded judgements at the time.

Today’s US equity market shows signs of similar concentration and froth. President Trump’s renewed tariff threats have unsettled markets as well as global supply chains, and fresh US export restrictions on chips to China prompted warnings from NVIDIA about billions in lost revenue. Meanwhile, valuations remain stretched.

Spotting market dislocations is one thing, acting on them is another. Investors may sense that sentiment is frothy but going against the crowd is always difficult. It’s particularly hard when the prevailing narrative is that “AI is the tide that will lift all boats” and investors are surrounded by highly speculative activity being wildly profitable.

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The Monty Hall Market: three lessons for today's investors

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others, goats. After the contestant picks, the host (who knows what’s behind each door) opens one of the remaining doors to reveal a goat. The contestant is then given the option to switch. While most stick with their initial choice, switching actually doubles the contestant’s odds of winning the car!

In today’s investment landscape, the dominance of the US – especially a handful of mega-cap technology companies – is hard to ignore. These firms have powered a disproportionate share of global equity market returns in recent years, and the US now accounts for around 75% of the MSCI World Index. The so-called “Magnificent Seven” have captured investor imagination and capital alike. But when nearly everyone is crowded around the same trade, it’s worth asking: what if we’re all looking behind the wrong door?

Lesson 1: The obvious choice isn’t always the best one

Lesson 2: Insight matters – but only if you act on it

At the end of 2024, cryptocurrencies and digital tokens were valued at $3.3 trillion – up 96% in a year. In a sign of the times, “Fartcoin” which was launched in October ended 2024 with a market cap just shy of $1 billion. That’s more than three times the peak valuation of Pets.com, the dot-com bubble’s poster child, which managed to go public and go bankrupt in the same year back in 2000.

Source: 1. World Bank, “Urban population (% of total population) – India”, data.worldbank.org.

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For a generation of investors raised on uninterrupted American outperformance, it may be time to reassess where the real risks – and opportunities – now lie.

And that’s the crux of it: markets aren’t always efficient – especially when investors are chasing hype over substance. As the Monty Hall problem teaches us, knowing the odds isn’t enough. You need to tune out the noise and have the conviction to switch, even when it feels uncomfortable.

Even with the optimal Monty Hall strategy, contestants only win two-thirds of the time. In investing, research shows that even top-tier managers only get it right about 60% of the time. That’s why broad and thoughtful diversification – across sectors, geographies, and styles – is so valuable.

Lesson 3: Nothing is certain – apart from death and taxes

Many investors today believe they’re diversified because they hold global index trackers. But with US stocks now making up nearly 75% of global benchmarks like the MSCI World Index, many portfolios are far more concentrated than they appear. That concentration is made more problematic by valuation levels. The S&P 500 trades at around 23 times forward earnings – well above its historical average and significantly more expensive than global markets, which average closer to 14 times. This discrepancy suggests that investors might be paying too much for the comfort of familiarity.

Meaningful diversification is about holding assets that behave differently – and the benefits are felt most when the prevailing market trends reverse. Investors need to ask whether their portfolios are truly positioned to weather regime changes. And if they aren’t, what’s stopping them from switching?

The Monty Hall problem teaches us that the obvious answer isn’t always the correct one. The same holds true in investing. Sticking with the US and big tech may have felt safe, until very recently at least, but sticking with what’s familiar can offer false comfort. In today’s environment, defined as it is by extreme market concentration and investor herding, the real edge lies in having the conviction to take a different path.

Reframing comfort zones

Ultimately, investors must always be sceptical about simply following the prevailing market consensus, as current prices already reflect those views. Proper diversification today also requires going beyond simply mirroring global benchmarks.

Just as switching doors improves your chances in the Monty Hall problem, being willing to look beyond the obvious and focus on where value is being overlooked is the key to long-term success in investing.

In hindsight it was obvious Japan was in a bubble

Source: FTSE, Orbis, 31 Jan 2025. Image Source: Grantuking via Wikimedia Commons. Benchmark data is for the FTSE World Index. Statistics are compiled from an internal research database and are subject to subsequent revision due to changes in methodology or data cleaning. Data shown through to January 2002 to show subsequent peak to trough decline.

Weight of Japanese stocks in the FTSE World Index

The US doesn’t always win

10-year annualised relative return of US vs world ex-US stockmarkets

Source: LSEG Datastream, Orbis, 31 Dec 2024. Relative total return of the DataStream US Market versus DataStream World ex-US Market indices.

US outperforms

ex-US outperforms

Is there any evidence of speculation today?

Source: CoinGecko, Cryptocurrency logos, 31 Dec 2024. *Total market capitalisation of all cryptocurrency.

~$3.3tn*

+96%

in 2024

Outside the US, there is better value on offer

Forward price-earnings ratio of US and World ex-US stockmarkets

Source: LSEG Datastream, Orbis, 31 Dec 2024. World ex-US is the Datastream World ex-US Market Index. US is the Datastream US Market Index. Calculated using I/B/E/S consensus 12-month forward earnings estimates.

World ex-US

22x

13x

45%

Meanwhile, US hyperscalers have been ramping up capital expenditures to chase AI dreams – with no clear line of sight to monetisation. Their ratios of capex to sales are rising sharply, and it’s not clear that returns will justify the outlays.

To learn more about Orbis Investments visit: Orbis Investments