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Effective Risk Management Through Diversification Requires a Long-Term Outlook

Maximizing returns in the short term could distract from vulnerabilities that will impact long-term returns, Mercer strategists warned

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  • Written by  Buyside Exchange staff
Effective Risk Management Through Diversification Requires a Long-Term Outlook

Managers may struggle to remember the importance of diversification during periods where all returns seem focused on one region or market, according to Mercer strategists.

Rich Nuzum, global chief investment strategist at Mercer, highlighted that in the US and other major regions, investment had been focused on the ‘Magnificent Seven’ stocks (Apple, Alphabet, Amazon, Meta Tesla, Nvidia and Microsoft).

Niall O’Sullivan, chief investment officer of global solutions at Mercer, said:  “There is no worse time in markets than when the simplest, cheapest thing has outperformed everything else and you wonder, why did I bother to diversify in the first place?”

The pair noted that governance is a crucial aspect of an investor’s ability to diversify their portfolio, with path-independent investors able to focus their assets while most large organizations are benchmarked to a peer group median.

Investors that are focused on their short-term performance need to consider what benchmark they are comparing against and size their risk budget accordingly.

However, Nuzum also noted that the Magnificent Seven’s strong performance in recent years has some crucial differences to past examples of market dominators, such as the dot-com bubble of the 1990s.

He said:  “There are different business models [within the Magnificent Seven]. There is some overlap at the edge but grouping these stocks is a bit of a mistake, which has become apparent in the year-to-date with two of them having negative returns and another being fairly flat.”

O’Sullivan highlighted that this could help companies consider risk in more ways than just quantitative.

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