In theory, there is no difference between theory and practice. In practice, there is. (Attributed to Yogi Berra) 

Economics is not known as a discipline that generates many catchy phrases, but one that has made the leap from textbooks to the vernacular is the idea of “no free lunch.” In economic terms, it is a reminder to consider hidden costs, opportunity costs, and externalities when assessing any course of action. 

While the no-free-lunch principle has proven to be robust, students of portfolio management are taught that there is, in fact, one free lunch—and it comes from diversification. I have been out of school too long to remember much of the theory behind that teaching, but I have seen many investments fail to work out as expected. As a result, I have a deep appreciation for its practical wisdom. Diversification is good in theory and, for most of my career, has also been good in practice. True to Yogi Berra’s observation, however, theory and practice are not always the same thing, and that has seemed particularly true in recent years when it comes to diversification. 

The diversification conundrum over the past decade seems to have roots in the emergence of a small number of U.S. technology companies as primary drivers of global equity returns. These companies have gone by various names (FAANG, FAANGMA, the Magnificent Seven), with shifting membership at the margin, but their persistent outperformance has been a defining structural feature of markets.  

Taken one level higher, this technology dominance has also driven the sustained outperformance of U.S. equities relative to non-U.S. markets. The allocator’s observation that “international stocks look attractively valued relative to U.S. stocks” has long been true—and just as long a recipe for disappointment.  The next step up the allocator’s ladder is the asset-class level.  Here, the heady mix of seemingly unassailable super-companies, increasing equity-market concentration, and rising valuations has caused public equities to outperform nearly every other asset class over the past decade. 

So yesterday’s winners are clear, as always. But investment strategy is an immutably forward-looking exercise, and investors are forced to think about whether their winners can continue to outperform and what might rebalance relative performance across asset classes.  Valuation levels for large-cap U.S. equities are an obvious and widely cited candidate, as the strong run of better-than-expected returns has likely come at the expense of some amount of future returns.  At the same time, several popular alternative asset classes, such as real estate and private equity, have experienced cyclically weaker performance just as public equity markets have reached new highs.  Each asset class has its own story, but these performance gaps tend to resolve over time, as a reduction in new investor capital and moderating valuations set the stage for future performance.  

Encouragingly, there are signs that diversification may not be dead after all. Over the past year, equity markets have been more balanced from a regional perspective, with non-U.S. markets outperforming. And while enthusiasm for AI-adjacent companies shows little sign of fading, market breadth appears to be improving both fundamentally and in share-price performance. Outside of equities, higher interest rates have restored fixed income as a genuine source of return rather than a “dead-money” stabilizer. While in private markets—an area of recent disappointment—increased transaction activity may be an early indicator of better days ahead. 

Taken together, we see an opportunity to earn “expected returns” across a range of markets. We are happy to take better-than-expected returns from any part of the portfolio, but don’t want to have to count on them.  An investor who emphasizes prudent diversification, high-quality partners, and disciplined execution does not know which individual asset class will outperform but can be confident that the overall portfolio will deliver.  The free lunch from diversification may not be served every day, but investors should position themselves to be at the table when it arrives. 
 

Michael Keenan, Chief Investment Officer. March, 2026