The End of "Mag 7 or Nothing"
For the past year and into the early months of this year — January and February in particular — the dominant theme in markets was artificial intelligence, and the prevailing belief was that an investor simply had to own the seven mega-cap technology stocks (the "Magnificent 7") to maintain any momentum. That assumption is no longer holding. This year those same names have lagged so badly that some have begun calling them the "Lag 7."
What is actually happening is that market leadership is broadening — not just away from those specific companies, but across asset classes, across company size, and across investment style. The evidence is striking when you look at the year-to-date numbers:
- Emerging markets are up roughly 29%, making them the highest-performing asset class.
- Value stocks are up about 16%, versus growth — the style most associated with the Mag 7 — which is up only around 4.5%.
- Small-cap stocks are up about 21%, the strongest performance by company size.
The lesson is that diversification matters across all of these dimensions, not just across individual names. Historically, leadership in markets always rotates, and that rotation is precisely what we are now watching play out.
Why the Small-Cap Strength Is Notable
The momentum in small caps has been particularly surprising. In the past, calls for a small-cap rally have repeatedly turned out to be "head fakes." This year, even amid genuine worries about the path of interest rates — and the well-known reality that higher rates are harder on smaller companies — small caps have performed strongly anyway. While "nothing surprises" anyone watching markets closely at this point, the best explanation is simply that historical pattern of rotating leadership. To both take advantage of that rotation and to cushion against volatility, an investor really needs a genuinely diversified portfolio.
The Hidden Danger: Portfolio Concentration
One of the biggest risks investors face today is portfolio concentration. This is a trap that catches even people who think they are diversified.
Does owning an S&P 500 index fund make you diversified? No — you need exposure somewhere else. The S&P 500 has become heavily tech-dominated, so an investor holding only that fund is effectively betting on a handful of companies in a single country. Consider that U.S. equities now represent about 60% of global market capitalization. Even an investor in a "traditional 60/40" portfolio (60% stocks, 40% bonds) — where part of that 60% equity allocation is global — is still leaning heavily on those same few names and that one country.
A Core-and-Satellite Approach
The recommended structure is an asset-allocation-based, core-and-satellite approach managed across the entire portfolio (the practice of an OCIO, or outsourced chief investment officer, firm that manages everything for a client). Individual investors can and should apply the same logic:
- Use passive strategies and ETFs for broad market exposure and to keep fees low — this is the "core."
- Layer in active strategies to capitalize on the areas where the indexes are not efficient — this is the "satellite." Small caps and emerging markets are prime examples of inefficient segments where active management can add value.
- Add an asset class best described as defensive equities — think of them as hedge funds, but liquid (some people call them "liquid alts"). These are funds, offered by many firms, designed to hedge against volatility, and they meaningfully improve diversification.
- Be disciplined about rebalancing, and be mindful of regions and countries when doing so.
This Is Not Just for the Wealthy
A crucial point: these principles are not reserved for the ultra-high-net-worth or high-net-worth investor with hundreds of thousands of dollars or more in a portfolio. They apply equally to ordinary people investing through 401(k)s and 403(b)s, which for most people is the primary way they invest.
Many of these savers hold their money in target-date funds — the "set it and forget it" option that automatically adjusts over time. The catch is that a great many target-date funds are built on index strategies, which reintroduces exactly the concentration problem described above. The right move is to ask pointed questions: How is the fund rebalancing? Is it an automatic rebalance back into sub-asset classes, or is a manager actively paying attention to specific countries and regions? Target-date funds are not an ideal vehicle — but for people who would otherwise be unsure how to invest at all, they are at least something rather than nothing.
How to Invest in AI: Creators, Builders, and Adopters
Investors still want — and arguably need — some exposure to the AI infrastructure and AI investment story. But the right way to get it is, again, through a diversified strategy rather than a concentrated bet, because diversification is what truly buoys portfolios over the long term.
The framework is to own all three waves of AI, which can be remembered as a kind of "reverse ABCs" — the creators, the builders, and the adopters:
1. The Creators (the first wave). These are the companies everyone already understands — Nvidia, Microsoft, Amazon, and Alphabet. This is the foundational layer of AI.
2. The Builders (the second wave). These companies build the physical ecosystem required to actually make AI work — the infrastructure that powers the creators. Examples include Vertiv, which provides cooling and power systems for data centers, and Eaton, another infrastructure name. This wave is where some of the underappreciated, "hidden" strength in the AI trade lives.
3. The Adopters (the third wave). These are the companies harnessing the power of AI and applying it to help other companies and other industries become more productive — affecting the bottom line by putting AI to work across the broader economy.
Owning across all three waves keeps AI exposure firmly within a diversified-portfolio framework rather than concentrating it in a few names.
What Clients Worry About — and What Actually Worked
When clients raise concerns, what is their biggest worry? Ideally, if the advisor has done the job well, clients have no worries at all. In practice, however, the dominant concern for all investors is volatility. The client base here is mostly institutions — foundations and endowments — which carry an additional layer of concern: they want their portfolios to reflect their mission, vision, and values, and some are under stress depending on where their funding comes from, including worries about cuts.
There is also some growing skittishness about private markets. These portfolios invest in private equity and venture (currently weighted more toward private equity), while private credit is performing very well.
The First-Quarter Stress Test
The value of this approach was proven in the first quarter. January and February were great; then "in March we all woke up and the world changed." Yet the diversified portfolio held up, buoyed by three specific areas:
- Real assets — a mix that uses ETF exposure — were up about 13.1%.
- Defensive equities (the liquid-alternative hedge described above).
- Private credit, or more precisely opportunistic credit, which did much of the heavy lifting. These last areas are accessed through single-manager exposure.
Those three areas did the job and carried the portfolio through the turbulence.
The Core Discipline
The overarching message tying all of this together is discipline around asset allocation. The right practice is to set a strategic asset allocation and not abandon it when "all heck breaks loose" — while still making measured adjustments along the way. When volatility struck, the conversation with clients was simply to explain that the portfolio was deliberately diversified, that the strategy was holding firm, and that what they were doing was working. That, in the end, is the entire point of diversification: it is what keeps a portfolio resilient when the world suddenly changes.
