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Diversification is a critical part of modern investing. This explains the exponential growth that the exchange-traded fund (ETF) market has enjoyed over the last decade.
Holding a large basket of shares helps investors to manage risk and target different growth and income opportunities. The trouble is that building a diversified portfolio can take a lot of time and effort. And buying a large number of individual shares can also be expensive after you add up separate transaction fees and Stamp Duty costs.
ETFs can substantially reduce (if not totally eliminate) these problems. Today, there are 3,600 of these pooled instruments listed on the London stock market. This gives investors a wide choice of funds to match their specific investment goals and attitude to risk.
Here are three top funds I think Stocks and Shares ISA investors could consider for a diversified portfolio.
Targeting AI stocks
Holding growth shares provides the potential for substantial capital gains as company profits take off. One top ETF I think is worth considering for this strategy is the L&G Artificial Intelligence UCITS ETF (LSE: AIAG).
As its name implies, it’s dedicated to companies whose technologies and operations are vital to the new tech megatrend. It holds 53 in all, including semiconductor manufacturer Nvidia, cybersecurity specialist Cloudflare, and cloud computing platform provider ServiceNow.
Sector ETFs like this one expose investors to greater concentration risk than ones diversified across industries. In this case, it could fall if economic conditions worsen and broader confidence in technology stocks drops.
But I think the enormous long-term potential of the artificial intelligence (AI) market still makes it worth a look. Statista believes the sector will grow from $244bn today to a stunning $1trn by 2031.
A passive income fund
My second choice for our diversified ISA is the iShares EM Dividend ETF. Having exposure to dividend stocks means investors can expect a smoother return during economic downturns when growth shares typically underperform.
Dividends are never, ever guaranteed. But with holdings in 111 dividend shares (including Petrobras and China Construction Bank), there’s still a good chance it will deliver a robust passive income even in the event of individual company shocks.
Its emerging market focus creates greater political and economic risk than ones based on shares in developed regions. However, it also allows investors to capture the benefits of soaring populations and wealth levels over the long term.
Great value
I believe the Xtrackers MSCI World Value ETF could be a great fund to consider to round-off our portfolio. Holding 400 shares across the world and a broad range of industries, it’s the most diversified vehicle on our list.
By focusing on cheap equities it offers two advantages. It helps to limit downside price risk, and over the longer term provides substantial scope for capital gains. Major holdings here include US tech shares Cisco and Intel, car manufacturer Toyota and banking giant HSBC.
The US is the fund’s single largest regional allocation, at 37%. This could leave it exposed to any broader rotation out of Wall Street equities. However, this weighting also means it’s well exposed to the long-term wealth building power of the US stock market.
