Europe equity offers differentiated returns

US technology stocks have been a powerful driver of returns in recent years, and now dominate many client portfolios. The challenge for investors looking to diversify their equity allocations is that a lot of common diversifiers could still end up moving in the same direction as US tech.

As this month’s chart shows, the Russell 1000 Growth Index is near-perfectly correlated with the S&P 500 (around 0.96 to 0.97), while it also has a high correlation with the MSCI World Index (around 0.91), which means even a global approach may have little diversification benefit. And if you look to Asia, many of the region’s largest stocks are also driven by the artificial intelligence theme.

However, even great tech revolutions are vulnerable to material pullbacks, particularly when markets are this concentrated, and valuations are looking this full. Which makes the case for finding true diversification from the tech trade even more important.

As we showed in April’s Chart of the Month, Europe offers diversification to US tech exposure through a genuinely differentiated return profile. The result is that the MSCI Europe Index has a correlation with the Russell 1000 Growth of around 0.55, while the MSCI Europe Value Index is lower still, at around 0.37 to 0.38. In fact, European value exposure offers investors the chance to benefit from “double diversification”, by region and by style.

Whether investors choose the broad index or the value index, the lower co-movement is exactly what can help smooth portfolio outcomes if the US growth index stumbles. On this basis, Europe can provide a strong diversifier and a differentiated source of return for equity portfolios.