Effective diversification is not passive

Produced in partnership with Orbis Investments.

Professional investors and advisers know that diversification works. It reduces portfolio risk and volatility and smooths out returns.

But diversification isn’t passive. It requires active portfolio monitoring and management to ensure investments are spread across asset classes, sectors, geographies, currencies and asset management style.

This is not a revelation and yet, when equity markets are running hot, investors can become less vigilant about diversification.

For many, their relaxed stance has paid off.

Since 2017, global equities have been the best performing asset class, delivering around 12 per cent annualised, primarily off the strength of US stocks, which account for around two thirds of popular indices like the MSCI All Country World Index (ACWI).

Geography aside, large cap stocks make up roughly three quarters of the ACWI and technology companies account for more than a third.

However, economic conditions are changing, volatility is heightened and US large caps look very expensive, reinforcing the importance of diversification, according to Eric Marais, head of clients and investment specialist at Orbis Australia.

“Markets are quite concentrated right now so diversification arguably matters more today, and investors have to be more intentional to achieve it,” he tells Professional Planner.

“The challenge is that this concentration has been good for client outcomes thus far because the parts of the market that are big, for example US technology stocks, have performed strongly over a multi-year period.”

The prolonged dominance of US equities has fuelled the notion of American exceptionalism: the belief that the US is inherently unique and superior compared to other nations, but history shows that market leadership rotates. It was Japan in the 1980s, technology, media and telecommunications stocks in the late 1990s, and commodities and China in the 2000s.

Orbis believes that another regime change is underway that will disrupt the dominance of the narrow group of US mega cap and AI-geared names. To avoid potential pain, investors should consider reviewing and, if required, reposition their portfolios to ensure genuine diversification.

“A passive, autopilot approach doesn’t give investors the diversification that it used to,” Marais says.

“In the context of global equities, you’d be forgiven for thinking that buying an ACWI ETF would provide broad diversification but you’re actually getting two thirds concentration in the US.”

“Some argue that big US domiciled companies have offshore components to their businesses, but the flipside is that many of the non-US companies in the ACWI also have exposure to the US, therefore, all roads lead back to concentration in the US.”

Time to reconsider emerging markets

To minimise risk and achieve genuine diversification, portfolios must hold assets that respond differently to market events.

This requires active decision-making grounded in valuation, independent research and a willingness to lean away from popular trends when they look expensive, Marais says.

When it comes to stretched valuations and popular trends, global equities and US large caps in particular stand out as obvious examples, although Marais admits that sentiment around the US remains “extremely positive”.

On almost every long-term measure, global stock markets have seldom been more expensive. World stock markets currently sit at the 93rd percentile relative to the past 50 years, the highest reading since the dot.com boom and bust at the turn of the century, based on research by Orbis Investments.

When valuations have reached similar levels in the past, the ensuing decade has resulted in “modest and disappointing” returns, Marais says, encouraging investors to consider shifting their attention to emerging markets.

After several painful years for emerging markets, Marais says geographical diversification is finally paying off, with emerging market equities outperforming global equities in 2025 and 2026, and signs of a broadening valuation advantage.

“Emerging markets look attractively priced, relative to historical valuations, and we expect attractive returns over the next decade,” he says.

“Our focus is very much at the individual stock level and, when you look at the fundamentals, there are a number of companies under-earning relative to their potential. If you capture these opportunities, you’ve got a very reasonable valuation multiple and, if the sentiment towards emerging markets improves and earnings and profits normalise and grow, you’ve got two ways to win.”

That said, it’s important to be selective, Marais says.

For example, Orbis has been positive on Korea for a couple of years but has little to no exposure to India, despite the country’s favourable demographic story. The manager believes India’s growth story is already priced into the market, making future returns harder to generate.

Orbis’ views on emerging markets and, within that universe, Korea and India, demonstrates its contrarian investment philosophy.

“Ultimately, we’re trying to buy businesses at a lower price than what they’re worth which means someone has to sell it to us at a price that is cheap, and the best way to maximise the probability of that happening is to have a contrarian approach,” Marais says.
“The most likely reason someone is going to sell something for cheap is because they’ve overreacted to bad news. Another common reason is apathy. Basically, we’re looking at parts of the market that have done less well and are often out of favour, which means we pick up a value bias.”

Two ways to lose

If undervalued emerging market companies represent two ways to win, broad equity market exposure represents two ways to lose, according to Marais.

Not only are many stocks in global indices expensive relative to historical valuations, market conditions and sentiment are changing.

“Diversification can fail when it matters most, particularly in index-heavy portfolios, because investors aren’t getting the diversification they need through passive exposures,” he says.

“Index concentration is often not deliberate, but structural. Passive investing hardwires yesterday’s winners into tomorrow’s portfolios. As those winners grow, they become larger weights, which amplifies momentum on the way up and risk on the way down.”

“If you’re paying a high multiple for those stocks, and their earning margins well above their historical norms, it feels like you’ve got two ways to lose.”

While the Orbis Global Equity Fund is around 20 percentage points underweight US equities relative to the ACWI, the manager sees plenty of opportunity in US mid-caps, where companies appear “reasonably priced” and share more in common with non-US developed market companies, Marais says.

The Orbis Global Equity Fund, which has returned 13.2 per cent annualised for the 10 years to 31 March 2026, is also underweight technology stocks, further demonstrating the firm’s willingness to lean away from popular trends when they look expensive.

“Market sentiment is still pretty brilliant towards anything related to AI but we’re seeing more dispersion because not everything in technology is doing well,” Marais says, adding that the current environment lends itself to finding interesting, idiosyncratic investment ideas that can help with diversification.