Unlike other global market indices, the S&P/ASX 200 (Index: ^AXJO) (ASX:XJO) is highly concentrated around a small number of stocks.
In fact, the top 10 stocks by market capitalisation make up more than 47% of the index's total weighting. This means that the other 190 stocks in the index are unlikely to have a major impact on the overall direction of the market unless the other 10 stocks move in the same direction as well.
I believe this presents a problem for investors looking to diversify their portfolios through fund managers or ETFs that just track the main index. In this case, investors will be over-exposed to a relatively small number of sectors that are not truly representative of the wider economy.
To get better diversification, I think it is important for investors to look at different sized businesses in a range of industries.
So here are eight companies that could be used as a good starting point for a diversified portfolio:
Healthcare – Virtus Health Ltd (ASX: VRT)
Virtus Health is one of the more reasonably valued healthcare companies and is Australia's and Ireland's leading provider of assisted reproductive services (ARS). The company is also in the early stages of expansion into Asia and has a number of positive long-term tailwinds behind it.
Retail – Retail Food Group Limited (ASX: RFG)
Retail Food Group is an attractive option for investors looking for growth and income with earnings expected to grow at double-digit rates over the next couple of years. The company owns and operates a number of food and coffee franchises and is rapidly expanding its footprint internationally.
Professional Services – IPH Ltd (ASX: IPH)
Unlike other legal companies, IPH operates in the high-margin, annuity style area of intellectual property (IP) law. It is expanding rapidly into Asia and is building scale which should improve operating efficiencies in the medium term.
Property – REA Group Limited (ASX: REA)
The shares always appear to be expensive but REA Group continues to deliver superior results. It is by far and away the leader in the Australian residential property listings market and has a number of exciting growth opportunities in Europe, Asia and North America.
Insurance – QBE Insurance Group Ltd (ASX: QBE)
QBE looks to have turned the corner following years of under-performance. The insurance giant has cleaned up its balance sheet and simplified its operations and this should see earnings momentum become positive. Higher interest rates in the US will also eventually improve QBE's investment returns.
Financials – Magellan Financial Group Ltd (ASX: MFG)
Magellan is a leading international fund manager with an extremely impressive long-term track record. Although recent performance has weighed on its share price, Magellan continues to see strong fund inflows as investors look to benefit from a potentially lower Australian dollar.
Information Technology – iSentia Group Ltd (ASX: ISD)
iSentia is the leading provider of media monitoring and intelligence services in the Asia Pacific region and boasts some of the world's largest consumer companies as its clients. With businesses becoming more digitally focused, demand for iSentia's services is expected to grow strongly over the coming years.
Speculator – Mobile Embrace Ltd (ASX: MBE)
Mobile Embrace is a small cap company that operates in the fast growing mobile advertising and payments segments. It has delivered exceptionally fast growth in revenues over the past four years and this is now being translated into profits. Despite this, it remains a speculative investment considering its short track record and the presence of some much larger players in the market.
Are you looking for even more stocks to diversify your portfolio?
