The economic shock of the pandemic revealed the absence – and potential benefits – of portfolios diversified by asset class, geography, and sector.
Giulio Renzi-Ricci, head of portfolio construction – Europe at Vanguard, says Covid-19 taught investors how to "hedge their bets".
But while it was a teachable moment, Covid-19 was not the reason why investors reacted strongly against an over-reliance on the 'magnificent seven' and the S&P 500.
It may have been the catalyst, but the components for economic change had been building up over the past decade.
"The pandemic changed a lot of the way the world works; socially, economically and globally," says John Husselbee, head of the multi-asset team at Liontrust.
"It shifted a secular theme into a higher gear, which is that globalisation is beginning to contract. We are seeing competition reducing, prices going up and, basically, people not getting on nicely.
"Geopolitical risk is increasing. You can say it started when former US President Trump came into power and said 'Make America Great Again', for example by putting trade tariffs on China, meaning China is no longer the biggest trading partner to the US – Mexico is."
As a result we have been seeing on-shoring, re-shoring and 'friend-shoring' amid rising geopolitical risk, which to Husselbee means "diversification is going to be more important than it had been in the past decade or more."
Matthias Hoppe, senior vice-president and portfolio manager for Franklin Templeton Investment Solutions, feels the same way.
He says: "The Covid-19 pandemic exposed the fragility of many investors' portfolios, which were heavily concentrated in a few asset classes, geographies, and sectors.
"The unprecedented disruption across regions saw highly correlated impacts hit developed and emerging economies. The volatility caused by the global health crisis have shown the need for a more balanced and resilient approach to investing."
Too many doughnuts
Leading up to Covid-19, there was a low interest, low inflation period, with an abundance of liquidity and some heady returns from growth stocks.
This may have helped investors who had been following veteran investor Warren Buffett's advice in 2017 of buying the S&P 500 and letting it run.
Mega-stocks such Apple, Amazon and Tesla – three of the so-called magnificent seven that have made long-term investors very rich over decades – have done well. But whether this works in the future, in a world that is increasingly fragmented, remains to be seen.
In fact, as the below graph indicates, there is a divergence of performance among the seven.
But then Covid-19 happened, leading to increased uncertainty, lower confidence and a tightening in financial and credit conditions.
Households saved more as a precaution and some firms made lay-offs and sold capital equipment. Central Banks moved to help ease the severity of the economic effects of the pandemic – cue inflation, rate rises and a new world order, where what worked before might not necessarily work now.
