There’s a certain belief, nay, a misconception, that investors have often been rewarded simply for being invested. Buoyant markets, abundant liquidity and a handful of dominant themes have made broad participation just enough to still generate strong returns.

Our CEO Philip Harris, discusses the impact of this from a private market perspective, while our CIO Chris Darbyshire assess the situation from his public market viewpoint. Both of them analyse why dispersion has returned to markets and what it means for those family offices and sophisticated investors allocating capital today.

CHRIS DARBYSHIRE: I don’t think so, at least not if you look at equity indices. Investors have been rewarded for simply being in the index, and I believe that you didn’t really need to go hunting for individual stocks or sectors to do very well indeed.

Most equity indices have performed strongly across the last few years… even laggards like the FTSE 100 are up significantly, which tells you there has been an appetite for equity risk across the board, and not just in the AI world.

Where it has become more difficult is at the asset-class level, as bonds have been much harder. Before the pandemic, unconventional monetary policy pushed up both bond and equity values and that really was easy money. Since then, equities have remained relatively straightforward thanks to the AI boom and the positive sentiment surrounding it, but bond markets have definitely not had an easy time.

The result is that investors have become accustomed to equity markets doing most of the heavy lifting, which has probably masked how difficult the environment has actually been in other parts of a diversified portfolio.

PHILIP HARRIS: I think we’ve got to put ‘easy’ in inverted commas. Historically, cash doesn’t really give you anything over inflation. Fixed income gives you a modest return over inflation, and equities give you more still. When I first started in markets, that was the generally accepted rule and the basis of portfolio construction. That basic framework hasn’t changed and by and large, investors will still do better in equities than almost anywhere else over the long run.

The complication today is concentration. A handful of very large technology companies are driving an enormous amount of market performance. If you strip those companies out, the picture becomes much less dramatic. The question isn’t whether equities work, but how much of today’s returns are being generated by a relatively small group of businesses.

And that’s important because concentration can create the illusion that investing has become easier than it really is, whereas the underlying market is often less exciting than the headline numbers suggest.

CHRIS DARBYSHIRE: I do think markets have narrowed considerably. Since the beginning of the year in particular, more and more performance has been driven by AI and technology-related themes. Equity markets currently have a very low tolerance for anything that isn’t AI-related. Quality companies with strong balance sheets and durable business models have actually underperformed dramatically against technology investment that is momentum-driven.

If you look at emerging markets, for example, and strip out the AI-related companies, performance falls away very quickly. This narrowness applies in bonds, which means it hasn’t simply been enough to identify the right asset class. You’ve had to understand the ecosystem within that asset class and identify which parts of it are actually generating returns.

That makes this a difficult environment for tactical asset allocation because it’s not enough to identify the broad trend. Investors increasingly need to understand where performance is actually being generated and where risk is accumulating beneath the surface.

PHILIP HARRIS: In private markets, absolutely. That’s where selection really matters. One of the key differences is that information isn’t distributed as evenly as it is in public markets. It also depends on what you're selecting, whether you’re investing in a healthcare start-up, a fintech business or an operator of care homes, or even areas such as defence, there is only so much data you can find. And then you look at what’s going on in the world, defence is the gift that keeps giving. It’s potentially been overbought more times this year than you can imagine, and it still keeps going. However, it’s among these assets that the dispersion of returns can be phenomenal.

I think now, the selection of individual equities has never really been something that we would support, preferring funds and passives. We might have listed equities, and there may be some things that we might say, “this is too good to be true” but by and large, we’ll select the asset class within an investment model, with commodities, private equity, hedge funds, and real estate. I think we need to define ultimately what do we mean successful selection.

CHRIS DARBYSHIRE
I totally agree. I mean, what does successful selection look like? It looks like what’s going to be successful next year, not what’s going to be successful tomorrow, and that is where listed markets are so difficult at the moment, because they’ve become mono-thematic. We have SpaceX about to dominate everything in markets, and to set various dynamics in motion, some of which we probably have never seen before, because of the size and uniqueness its IPO.

With private markets, you’re taking a view for several years, which is probably a good discipline at the moment, look beyond the next year, look beyond momentum, look beyond themes, because all of that will change at some point. History tells us we probably are near a turning point for that. The internet boom is a good comparison to what we’re seeing now and there are various echoes of that you can point to.

CHRIS DARBYSHIRE
For me, it is about identifying what is not already successful. Everything currently revolves around AI, momentum and a handful of dominant names. History suggests that these periods eventually turn. If the internet boom is a useful comparison, then investors should remember that today’s winners are not tomorrow’s winners.

The challenge is that momentum can feel irresistible while it’s happening and investors naturally want to own what’s working. The difficulty is recognising when a theme has become consensus and when that happens, the best opportunities may already be elsewhere.

PHILIP HARRIS
I completely agree and it is incumbent on us to do that as advisors. It’s very easy to say “Oh, let’s sell you some Anthropic, or sell you a secondary SpaceX, but that’s hardly adventurous and that’s not going to give you your 10x return. We identify the next opportunities before they become obvious, and that’s where the real value lies. I mean, Base Power, which we selected at the beginning of the year, is already up three-fold since then, and that’s something really special.

Successful selection isn’t buying what’s fashionable because by the time everybody wants access to something, a significant amount of the value creation has usually already occurred. The discipline comes in identifying the themes early enough that you are participating in the growth, rather than paying a premium for someone else’s success.

CHRIS DARBYSHIRE: A dispersed market can hide a lot of risk. At the index level, volatility can look surprisingly low. But when you drill beneath the surface, individual sectors and individual companies can be behaving very differently. That can lead investors to underestimate risk and lose faith in diversification because a small number of themes appear to be driving everything.

But it’s also why, ultimately, diversification is going to be your friend because when you can’t get every bet right, having a spread of bets is going to work for you and reduces your downside risk. Yes, it reduces your upside too, but the middle zone is a good way to proceed if you want a highly diversified portfolio, and not chasing the themes out there is a good way to achieve some return without a great deal of risk. It also allows investors to remain invested without having to predict every twist and turn in the market.

PHILIP HARRIS: I think you’ve got fundamentals to stick to, but it depends on what you’re actually aiming for. Are you running a portfolio of multi-asset class portfolio or are you focusing on private markets? Either way you stick to fundamentals. History has shown that, by and large, this delivers the returns that are risk adjusted. That’s the important term: risk adjusted. They are the kind of returns most investors seek.

Investors don’t necessarily need to predict every upside or downside, what they do need is a framework that allows them to participate while managing the inevitable periods when markets don’t behave as expected.

CHRIS DARBYSHIRE: In public markets, if you look at the fund management community, the ones that invested in tech early and stuck with it during the bad times have come through and are still fund managers. Others, due to survivorship bias, have fallen by the wayside. The dominance of momentum as a factor has made some people look like winners while other investors in other types of products are still feeding off of this original tech boom that led up to the internet boom, which went quiet for 10 years, and kicked back in in the teens.

In the long-term, a winner is someone who simply can generate fairly consistent returns with an acceptable, preferably below average level of risk across time. In public markets that means sustaining good rates of growth over time without losing credibility or the trust of investors. You have to be middle of the road at periods, and you can’t outperform over the long run without underperforming on occasion… that’s often something that’s forgotten by investors. In the long term, a successful public market investment looks like a hedge fund that’s producing 7% a year, but it comes without the complexity premium and with a daily liquidity guarantee, and that is the magic ingredient for public markets.

PHILIP HARRIS: I support that, because actually, what are you doing with your public market investment? You’re looking to have that as a cornerstone of the foundations of your portfolio. Your capital increase in value, but then you want to add some higher risk, and potentially higher return. The volatility is still there, but you don’t see it because it’s illiquid, so you only see the price flat until there’s another round, and then it will go up or down, but you don’t see the kind of intra-day intra-week, intra-month movement, so it appears that there’s no volatility there. The hand-to-mouth existence of some of these entities can actually be quite astonishing. If that were translated to the public markets, then investors would run away, because they’d be scared that you might not be there tomorrow, so I think that’s important.

PHILIP HARRIS: It’s difficult to foresee anything, particularly when it involves the future, but let’s return to fundamentals. It’s not about being dull and having a 60-40 portfolio – there’s got to be some momentum in there. It’s being able to get out of positions as much as getting in, and it is the exit that’s the most important. Never mind that you know the entry, and in the private market space that’s a lot easier to achieve because of the secondary market and so on. Ultimately invest in a way that does follow momentum but also invest in strategies or structures that enable you to change them, not necessarily overnight, but in a way that you can hedge.

You might be very long in US tech, but if there’s recession then you should invest elsewhere either in the asset class or in a different asset class: Japanese government bonds; the Swiss franc, or gold come to mind.

The takeaway is actually that the fundamentals are still there, but for the current environment and onwards, you can allow some momentum to have an influence and an impact in where you are invested.

CHRIS DARBYSHIRE: I would add to that and say there are some themes that will probably persist into the next decade. Broad government bonds might be a problematic class rather than a safe haven. This theme has a lot of macroeconomic drivers, and macroeconomics doesn’t change overnight. The other thing is that technology is still going to be a theme of sorts. At the moment you’ve got huge amounts of capital chasing various types of products that are becoming extremely expensive. The scale is so huge that it’s moving the needle on a macroeconomic aggregate data level – GDP numbers are changing because of the AI boom, inflation numbers are changing – so I think that is probably one theme that has less sustainability.

If I had one final takeaway for the next decade it would be patience. If you are an investor who hasn’t participated in the tech boom and feel you’ve missed out, or you have, but feel like you haven't got enough exposure, then I think your patience will be rewarded. As long as there other assets in your portfolio with decent business models and good managements, they will come good at some point, and the flavour of the month will change again.