Tech stocks such as Nvidia and Google have dominated global equity markets so much that this has "skewed" fund manager behaviour and led to high levels of correlation between DFMs, Orbis has warned.
Dan Brocklebank, head of UK for Orbis Investments, said too many management groups had been lured by the attraction of the so-called 'magnificent seven', the US technology giants dominating global equity indices.
He explained: "The Magnificent Seven effect has skewed behaviour and markets in recent years, because of the high growth-stock domination of markets.
"Markets are unusually concentrated as a result and so we have seen portfolio managers and investment teams shifting their positioning to make sure they are not missing out.
But what this meant, he warned, was that the big funds are still "very, very correlated".
Brocklebank said: "I think it is a big problem because fund selectors may be less well diversified in practice than they think they are on paper.
"You do not need fancy AI to know that at some point this is going to be a significant problem – just look at the correlations across the big funds, and think back to what happened in 2022."
He pointed to the downside risk in blending funds together in a discretionary portfolio which are all the same or similar styles, and explained that using a variety of styles lent itself better to mitigating downside risk and helping to boost long-term performance (see graph one and two, below).
Graph one:
Moreover, he suggested there could be a perverse incentive to following the herd, in terms of short-term company performance that would look good to shareholders or private equity owners.
He said: "In my view, a lot comes down to the strategy of the firm and the its ownership structure. One aspect of manager selection that does not get enough attention is how the overall firm is being run and where their incentives lie.
"Is their priority to deliver smooth quarterly results to the market, grow AUM or deliver the best long-term performance? That ripples through to the portfolio management and this influence can be very powerful."
Graph two: blending styles
According to Brocklebank, advisers should examine what their fund managers are doing in relation to others, to see whether there is enough diversification and not too much correlation.
He said: "Generally you should expect portfolio managers to go through their own individual performance cycle and so there will be diversification benefits from holding multiple managers.
"When a manager underperforms from on a relative basis, even over a short period of time, this can lead to a confrontational environment and can certainly create pressure on managers."
As a result, managers may face the temptation to not deviate too much from what other investment managers are doing. But this can mean that diversified portfolios may end up not being as diversified as people think.
