WEEKLY E-MAIL

26 November 2025

WHY DIVERSIFICATION MATTERS MOST WHEN MARKETS BECOME UNCERTAIN

By Adam Blanchard

Recent market conditions have been marked by sharper movements across both Australian and global equities as investors navigate shifting expectations around interest rates, inflation trends, and ongoing geopolitical tensions. While these periods of volatility can feel unsettling, they remain a normal part of long-term investing. What matters most is understanding the forces driving this volatility and how disciplined portfolio construction helps manage the risks associated with it.

A useful distinction is between systematic and unsystematic risk. Systematic risk affects the entire market, including central bank policy changes, global economic slowdowns, energy shocks, or broad swings in investor sentiment. These risks cannot be avoided, regardless of diversification. Unsystematic risk, however, is company- or sector-specific and includes factors such as profit downgrades, regulatory changes, governance issues, or operational disruptions. This form of risk can be significantly reduced through diversification, ensuring that no single company or industry has the capacity to materially influence portfolio outcomes.

Concentration risk is one of the most common contributors to poor performance during volatile periods, particularly when investors hold large overweight positions in individual shares. Two recent Australian examples are CSL and Commonwealth Bank. CSL, despite being one of Australia’s highest-quality global healthcare companies, delivered a share price decline of roughly 35% over the past 12 months, with its share price also falling by around 18% over the 2025 financial year. Even great businesses experience periods of weaker performance, and investors who hold too much in a single stock can face significantly higher volatility as a result.

Commonwealth Bank tells a similar story from the opposite direction. While its 12-month return has been close to flat, the 2025 financial year saw its share price rise by more than 45% as the market responded to improved sentiment and stronger earnings. Investors with unusually large positions in CBA experienced a level of portfolio movement that was driven not by overall market trends, but by one company, and one sector, alone. These examples highlight a core principle: even exceptional companies can create excessive risk when held in concentrated amounts.

This is where diversification plays its most important role. A portfolio spread across industries, geographies, and asset classes ensures that performance is not tied to the fortunes of any single part of the market. Different sectors respond differently to economic conditions: defensives tend to hold up when growth slows, international equities provide exposure beyond the concentrated Australian market, and fixed interest continues to deliver stability and income for investors with more moderate risk profiles. As Ray Dalio aptly states, “Diversifying well is the most important thing you need to do in order to invest well.”

A critical component of diversification is the correlation between investments. Correlation measures how different assets move relative to one another. When holdings are highly correlated, they tend to rise and fall together, limiting the benefits of diversification. Low-correlation or negatively correlated assets behave differently under the same conditions, helping smooth returns and reduce portfolio volatility. Importantly, effective diversification requires both a sufficient number of holdings and a mix of investments that do not all move in the same direction at the same time.

Maintaining portfolios close to their agreed risk profiles is central to managing both systematic and unsystematic risk. Over time, strong performance in certain areas can push portfolios away from their intended structure, usually unintentionally. A disciplined rebalancing process trims overweight exposures and reallocates towards areas offering better long-term value, ensuring portfolios remain aligned with their strategic objectives rather than allowing market movements to dictate risk exposure.

Periods of volatility will always occur, but they do not need to derail long-term outcomes. By understanding the sources of risk, avoiding concentration in individual holdings such as CSL or CBA, and remaining committed to diversification and disciplined portfolio management, investors place themselves in the strongest position to navigate uncertainty and benefit from market recoveries.

Adam Blanchard
Senior Financial Planner
SMSF Specialist Advisor™
Authorised Representative No. 1238027

If you have any questions or comments, please email me at adam@gfmwealth.com.au

Disclaimer: This document is not an offer or invitation to any person to buy or sell any interest in or deposit funds with any institution.  The information here is of a generic nature, and does not take into account your investment objectives or financial needs.  No person should act upon this information without firstly seeking competent, professional advice specifically relating to their own particular situation.

Copyright: © This publication is copyright. Subject to the conditions prescribed under the Copyright Act, no part of it may, in any form, or by any means (electronic, mechanical, microcopying, photocopying, recording or otherwise) be reproduced or transmitted without permission. Enquiries should be addressed to GFM Wealth Advisory.