Investors should look to allocate assets by sector as it can offer more scope for diversification than by country or region amid the rise of the ‘Magnificent 7’, globalisation and market concentration, Asset Risk Consultants (ARC) has stated.

Its analysis suggested there was greater potential for diversification through sectors rather than countries, with ARC Research client director, Shaun Le Messurier, arguing that tactical asset allocation by geography was becoming “increasingly problematic”.

He said that globalisation, the growing dominance of US stocks, and high levels of market concentration had materially reduced the potential to add value through tactical tilts at the regional or country level.

“Given these challenges to tactical asset allocation, our analysis suggests a better starting point for investors would be global sector exposure,” Le Messurier stated.

ARC noted that an equally weighted portfolio holding two stocks would have an effective count of two, and if the two stocks were held with a ratio of 90:10, the effective number of stocks would be just 1.2 as one stock dominates the portfolio.

Its analysis showed that the dominance of the Magnificent 7 and US equities meant that, despite 23 countries being involved in the study, the effective count was just 1.8.

The firm then compared this to sector weightings, starting with 11 sectors, where the effective count was seven, which ARC highlighted as evidence that considering sectors rather than geographies leads to more potential for diversification.

ARC’s analysis also found that sectors were likely to be less correlated than countries, and that the dispersion of possible outcomes was “significantly greater” for portfolios managed tactically at the sector level than at the country level.

“It is time for perceptions to evolve and for sector exposure to be more carefully considered, at a minimum in parallel with geography,” Le Messurier commented.

“Thinking about global equity exposure through the lens of geography has become an increasingly binary approach, with the decision on the allocation to US shares dominating all other decisions.

“To quote the Dalai Lama: ‘Our world has greatly changed: it has become much smaller. However, our perceptions have not evolved at the same pace’.”

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