Rethinking Diversification in an Interconnected Global Market

For decades, building a diversified retirement plan portfolio appeared relatively straightforward. Participants were told to mix stocks with bonds, include U.S. and international equities, and rebalance periodically. These days, many advisers argue those assumptions deserve another look. As globalization has tied markets more closely together, plan fiduciaries are being forced to think more critically about where diversification actually comes from when creating a lineup from which participants can choose.

“‘Let’s make a more integrated world economy.’ Well, guess what comes with that? We all start to move in lockstep,” says Rob Massa, managing director and retirement practice leader at Prime Capital Financial. “You want something that’s going to offset some of that risk, and it’s becoming increasingly difficult to do in the 401(k) arena.”

That challenge is reflected in the numbers. According to equities manager Talaria Asset Management Pty Ltd., more than 90% of the world’s investable assets now move in step with the S&P 500 Index, compared with just 26% in 1995. Measuring correlation with the S&P 500 from 2021 through 2026, Talaria found that, out of a scale of 1.0, many assets such as real estate investment trusts (0.82), equity hedge (0.81), global aggregate bonds (0.61) and global Treasury bonds (0.58) were less diversified than commonly thought.

However, diversification is not obsolete. Instead, advisers say fiduciaries need to look beyond traditional definitions of diversification and examine what risks participants are actually taking.

Looking Beyond US Markets

One shift has been the growing importance of international diversification. For years, many advisers argued that investors in large U.S. companies already had meaningful international exposure because multinational corporations generated a substantial share of their revenue overseas. While that remains true, sources distinguish between owning U.S. companies with foreign sales and owning companies in international markets that are influenced by different economic conditions.

“Most people typically have a large-cap international,” Massa says. “But you’re going to have to think small-cap. Emerging markets become a much more critical part of the menu now.”

John Kirkpatrick, a senior institutional investment strategist at Henderson Brothers Financial Partners, says his firm’s philosophy is to provide participants access to a broad global opportunity set, rather than trying to predict which region will outperform next.

“We’re not placing these investments for the participants,” Kirkpatrick says. “We’re just trying to provide them the global opportunity set. Providing broad U.S. exposure, broad international—whether that’s developed or emerging—those have always been core to our investment philosophy.”

Diversification Is More Than Geography

Advisers also caution that simply buying an index fund no longer guarantees broad diversification.

The rapid rise of mega-cap technology companies has made the S&P 500 increasingly concentrated. A BlackRock study from April found that nearly half (49%) of the index’s value came from its 20 largest companies.

Phil Senderowitz, managing director of Strategic Retirement Partners, says fiduciaries should think carefully about concentration, regardless of whether it exists inside an index fund or an actively managed portfolio.

“If it was not the index, [and] you just looked at an ABC portfolio and said, ‘Here’s what this portfolio looks like,’” Senderowitz says, … most [certified financial analysts] would say that’s not diversified and you’re putting portfolios at undue risk.”

That concentration also complicates evaluating funds’ performance. A fund that significantly outperforms peers may simply have held more of the market’s recent winners. Massa recalls jokingly referring to one particularly strong-performing target-date fund as the “Nvidia target-date,” reflecting the possibility that much of its outperformance stemmed from exposure to a single stock.

“If you didn’t know that, and you just looked at the performance and the risk-adjusted performance, you’d think, ‘Wow, this is the place to put my money,’” Massa says. “It’s our job as advisers to have exactly these conversations as to the why something is performing really, really well.”

Rather than focusing on returns, Massa says his firm evaluates whether managers generated those returns while taking an appropriate amount of risk.

“A good 80% to 90% of the performance comes from the asset allocation, not the underlying funds themselves,” he says. “I’ve often been surprised at some of the poor underlying funds that are in a target-date, yet the target-date itself outperforms because of good allocation. The target-date manager is doing their job, even though they’ve been delivered a hard set of marbles to work with.”

Building Portfolios for the Long Term

Ultimately, advisers say diversification is less about finding the perfect asset mix than it is about constructing portfolios with which participants can stick throughout market cycles. Senderowitz says investment committees should resist evaluating decisions solely through hindsight.

“Should you have just said, ‘Put everything into a technology fund 10 years ago?’ Yes, you should have. You didn’t,” he says. “But that’s not how you can look at investing. It’s trying to make a decision that accounts for the potential downsides.”

That perspective becomes particularly important for participants approaching retirement, when large losses can have lasting consequences. Rather than maximizing upside, advisers say their objective is often to reduce the severity of downturns enough that participants remain invested.

Education is important as well. Kirkpatrick says Henderson Brothers provides plan participants with specialized educators who teach the basics of long-term investment and plan benefits, as well as licensed advisers who can answer investment questions. Armed with knowledge, investors can stay focused on long-term goals instead of reacting to short-term volatility.

“The goal is to keep them invested,” Kirkpatrick says. “We communicate that there will be volatility. However, we’ve constructed a portfolio or a lineup for you to use that will try to smooth out the ride as best we can.”