Thoughtful Diversification: Rethinking the Building Blocks of Modern Portfolios

This article is part of an educational series designed to help investors understand how we approach portfolio construction at Lulworth Investment Partners and the principles that guide the way we build and manage portfolios. It is intended for general information only and should not be viewed as investment advice or a recommendation to buy or sell any asset. Anyone considering an investment should reflect on their own objectives, financial position and tolerance for risk, and seek regulated financial advice if needed.

The Limits of Traditional Diversification

For decades, high quality bonds and global equities formed the cornerstone of balanced investment strategies. Their long standing negative correlation allowed investors to combine growth and stability within a single portfolio. That relationship has shifted. The market dislocation in 2022, the volatility in April 2025 and the Iran conflict in March 2026 each demonstrated that the assumptions investors once relied on no longer hold in the same way.

We believe the global environment is now more prone to these shocks. Tighter supply chains, reduced global integration, elevated government debt and increasing geopolitical tension have created a more volatile backdrop for growth, inflation and interest rates. In this setting, bonds can lose their defensive qualities precisely when investors most need them. When major asset classes move in the same direction, the protection that diversified portfolios are designed to provide can break down.

Although bonds still have an important tactical role and remain useful for generating income, the conditions that supported traditional portfolio construction have changed. A resilient, modern portfolio needs more than a single counterbalance to equity risk. It requires a wider mix of return sources that behave differently across the economic cycle. At the same time, defensive assets such as gold have at times shown increased correlation with risk markets, largely because they now serve a dual purpose: acting as an inflation hedge while also behaving more like a risk asset in certain conditions.

The traditional diversification framework that underpins many multi asset and wealth management portfolios has become increasingly “two dimensional”, with returns heavily reliant on the direction of global equities. This leaves investors more exposed to real losses and less protected against the range of potential outcomes in an uncertain economic and geopolitical environment.

At Lulworth, our objective is to grow our clients’ capital in real terms across a wide variety of market conditions. The changing behaviour of traditional assets reinforces the need for a more deliberate approach to diversification. This article sets out how we think about achieving that through what we call Thoughtful Diversification.

Rethinking Equity Exposure

Equities remain a vital engine of long term growth, but how investors access them matters. Many wealth and investment managers rely on blue chip stocks, global equity funds or ETFs. It is often assumed that holding a global equity fund provides broad geographic diversification. In practice, funds that track their benchmark closely are far more concentrated than they appear. The United States alone accounts for close to 70% of the global equity index and, within that, a handful of dominant technology companies, the so called “Magnificent Seven”, represent roughly one third of the US weighting. What looks like a global portfolio is, in substance, a significant exposure to a small group of US technology stocks.

This concentration has been richly rewarded in the post Covid period, as loose monetary policy, strong earnings growth and rising optimism about AI pushed technology valuations to historic levels. For a time, owning a global or US index meant owning the best performing companies in the world. But that tailwind may be fading. Stretched valuations, rising AI related capital expenditure and growing regulatory scrutiny have begun to weigh on the sector. History suggests that when a handful of stocks drive the majority of market returns, the reversal, when it comes, can be sharp. Whether this time proves different remains to be seen, but the risk of being heavily exposed to a small group of companies facing similar headwinds is not one we believe investors should take on unknowingly.

Our approach to equities brings together several complementary tools:

• High conviction, active equity selection focused on bottom up company analysis and exploiting market inefficiencies.

• Passive funds that provide low cost access to specific regions, themes and sectors

• Long short and market neutral strategies that introduce alternative sources of return and reduce reliance on market direction.

Together, these tools allow us to be more responsive across market cycles, to capture returns wherever they arise and to avoid the unintended concentrations embedded in mainstream global benchmarks.

Rethinking “Alternatives”

We are not alone in questioning the effectiveness of traditional “60:40” (equity and bond) portfolios. In recent years, many firms have turned to so called alternative assets such as private equity, private credit, real estate or infrastructure, usually accessed through collective investment vehicles.

For large institutional investors with long time horizons and minimal liquidity requirements, these asset classes can play a useful role. For individual clients, the picture is often different. The ability to adjust positioning as market conditions change is an important part of active portfolio management. Strategies that tie up capital in illiquid structures can leave investors unable to act when opportunities arise or risks need to be managed.

There is also a deeper structural issue. Many alternative asset classes are influenced by the same forces that move public equity and bond markets. Infrastructure and real estate, for example, remain highly sensitive to interest rates and growth expectations. In risk off environments, they can fall alongside equities, offering little of the diversification investors expect. Some managers sidestep this by removing daily pricing, meaning that private credit, private equity and venture capital funds do not show losses in real time. But the absence of a daily price is not the absence of risk. In reality, the appearance of stability can mask the vulnerabilities of highly levered, unquoted strategies during periods of inflation or tighter financial conditions.

At Lulworth, we take a different view. We start with liquidity. We only select investments that support the liquidity profile our clients need. Liquidity is not merely a convenience. It is essential for maintaining resilience and optionality during periods of market stress.

Beyond liquidity, we look for investments that provide genuinely independent return streams; assets and strategies whose performance is driven by different factors from equities, both in benign conditions and under stress. An asset that diversifies in calm markets but behaves like equities during periods of volatility provides limited real protection. The strategies we select expand our portfolio toolkit for managing risk and capturing targeted opportunities, adding stability without sacrificing liquidity. We also hold commodities, which respond to entirely different drivers such as real interest rates, currency dynamics and geopolitical tension, providing further support when traditional assets struggle.

Building Portfolios Fit for the Future

Thoughtful Diversification is not about adding complexity. It is about building portfolios that are better suited to a world where economic growth and inflation are less predictable, geopolitical risks are more persistent and traditional asset price correlations are less reliable. Strategic asset allocation, done well, is not about owning more asset classes. It is about owning the right ones, in the right proportions, for the right reasons. By combining a carefully constructed portfolio with a disciplined approach to risk management and liquidity, we aim to build portfolios that are more resilient, more adaptable and better positioned to deliver real returns, whatever the market environment.

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