Harry Markowitz originally outlined the importance of diversifying investments in his PhD dissertation, which he wrote in the early 1950s. In defending his thesis to a committee at the University of Chicago, the future Nobel laureate was warned his ideas were so radical that they might fall outside the scope of economics.
It’s hard to question his work 70-plus years later. Countless investors have derived significant economic benefit from diversification and its importance has arguably earned renewed recognition of late.
But what genuinely qualifies as a sensibly or suitably diversified portfolio? This question has occupied the minds of investors, fund managers and academics ever since Markowitz first put pen to paper, and the answer may be in as much danger of being obscured today as it has ever been.
Take a passive fund that tracks the S&P 500. For a while, most obviously during the glory days of the Magnificent Seven US technology stocks, it was possible to suggest there was little need to explore beyond such a vehicle in the search for attractive returns.
Yet this argument clearly flew in the face of diversification. Ultimately, it endorsed investing not just in a single market but – even more perilously – in a handful of businesses concentrated in a single sector.
With US exceptionalism on the wane, more investors now acknowledge the appeal of diversifying geographically. Emerging markets led all-comers in 2025, with several Asian economies performing notably strongly.
So does it automatically follow that the most prudent course of action now is to invest in a passive fund that tracks, say, the largest and best-known companies in Asia? Ah, if only investment life were so straightforward.
Look closely at Asian markets right now and you should quickly recognise the very same issue that has defined the US arena in recent years. A tiny number of companies – all of them mega-cap tech businesses – have come to dominate benchmark indexes.
In Taiwan, for example, the mighty Taiwan Semiconductor Manufacturing Co accounts for approximately 45% of the Taiex Index. In South Korea, meanwhile, Samsung Electronics and Hynix – two of the world’s three leading makers of high bandwidth memory chips – lay claim to around a third of the Korea Composite Stock Price Index.
Granted, there’s a lot to be said for holding these businesses – particularly while the AI boom continues to unfold at pace. Yet the spectre of concentration risk, as it’s known, can’t be ignored.
This is why there has always been merit in diversifying not just between, but within geographies. In Asia, as in the US or any other region, it can be unwise to place all your eggs in one basket – even if it’s a basket comprised entirely of trillion-dollar-valued, tech-centric, big-name businesses.
Although it can sometimes be hard to believe as much amid the all-consuming noise of the AI revolution, smaller companies generally outperform their more substantial counterparts over time. The trick lies in identifying those that might be truly capable of this feat.
One option is to look further down the supply chains that have kept the established giants ticking over. In Taiwan, for instance, this might lead investors to the likes of Chroma ATE, which makes testing equipment for semiconductor producers, or Taiwan Union Technology, a specialist in the laminates widely used in high-end computing.
There are also opportunities outside the sphere of tech, of course – even in a market as heavily AI-focused as South Korea’s. ‘K-beauty’ company Classys, which operates in the fast-expanding aesthetics arena, is a good illustration of the sort of business that routinely escapes many investors’ attention.
Alongside in-depth analysis and informed stock picking, active management is key here. While index-tracking funds are ostensibly intended to encourage broad market participation, passive investing can become a victim of its own success.
The danger lies in the fact that a given stock’s weighting in an index will reach its peak at exactly the point when the price begins to tumble. This means passive investors are likely to suffer an outsized negative impact in terms of performance.
This is precisely what happens whenever a constituent of the Magnificent Seven hits a rough patch. It’s one of the many reasons why the run-up to an Nvidia quarterly earnings call is likely to generate more anticipation – not to mention more anxiety – than the average announcement from the Oval Office.
Most investors are now wise to the need to look further afield. But those who think this simply means adding Asia’s titans to those of the US are barely scratching the surface of real diversification.
Experience and empiricism alike indicate the task requires much more dedication, imagination and insight. All else being equal, such qualities are unlikely to be derived either from a cursory survey of headlines or from an investment philosophy that aims merely to be the market rather than to beat it.
Xin-Yao Ng is co-manager of Aberdeen Asia Focus. The views expressed above should not be taken as investment advice.