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.

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Here, I’m going to highlight two theme-driven ETFs I like the look of right now. I think they could be worth considering for a diversified investment portfolio in February.

An ETF for the AI revolution

While AI stocks have experienced some turbulence recently, I continue to like the theme. Over the next decade, this technology‘s going to transform nearly every industry, creating a lot of opportunities for investors.

Now, one ETF that offers exposure here is the L&G Artificial Intelligence UCITS ETF (LSE: AIAG). This is a niche product from Legal & General that’s focused purely on AI stocks.

In total, it provides access to around 55 different companies. And I see that as a huge plus because, right now, we don’t know for sure who the real AI winners are going to be.

Another key feature of this ETF is that it doesn’t have massive weightings in specific stocks such as Nvidia or Alphabet (Google). This reduces risk for investors.

There are plenty of risks to consider, of course. One is that the AI industry is moving at a rapid speed and new companies/technologies are continually popping up. We saw this recently with Chinese AI start-up DeepSeek. Its emergence sent a lot of US AI stocks down.

Taking a long-term view however, I think this ETF will do well. Ongoing fees are reasonable at 0.49% a year.

Cybersecurity just became more important

Now, the emergence of DeepSeek’s low-cost AI model has definitely created uncertainty in some areas of the AI sector. For example, there are now some question marks in relation to long-term demand for Nvidia’s high-powered AI chips.

However, one thing we can be certain of is that, looking ahead, demand for cybersecurity will remain high. If anything, the emergence of Chinese AI models will actually increase demand for sophisticated cybersecurity solutions.

One ETF I like for exposure here is the Legal & General Cyber Security UCITS ETF (LSE: ISPY). It provides broad, global exposure to the cybersecurity industry. Overall, there are around 35 stocks in the ETF. At the end of 2024, top holdings included Broadcom, Cloudflare, and CrowdStrike.

It’s worth pointing out that this ETF’s been around for a while now. And it’s done pretty well over the long run. For the five-year period to the end of 2024, it returned 71% (in US dollar terms), or 11.3% a year. However, past performance isn’t an indicator of future returns.

If the tech sector was to experience a major pullback for some reason (eg rising interest rates), this product could underperform. There’s also some company-specific risk here as this ETF does have quite large weightings in certain stocks.

I believe it’ll do well over the next five years on the back of the growth of the cybersecurity market however. Ongoing fees are 0.69% a year.

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Here, I’m going to highlight two exchange-traded funds (ETFs) that have beaten both of these major indexes over the last five years. I reckon they have a good chance of outperforming these indexes over the next decade, and are worth considering as part of a diversified portfolio.

High-quality stocks tend to outperform

First up we have the iShares Edge MSCI World Quality Factor UCITS ETF (LSE: IWQU). This is a global tracker fund that focuses on high-quality companies within the market (those with a high return on equity, low debt, and low earnings variability).

I’m a big fan of ‘quality investing’ and the performance of this product illustrates why. Over the five-year period to the end of August, it returned 91.3% in US dollar terms versus a return of 85.8% for the regular iShares Core MSCI World UCITS ETF and 38.8% for the iShares Core FTSE 100 UCITS ETF (in GBP terms). In other words, it smashed the Footsie and outperformed the standard global ETF by about 1% a year.

It’s worth noting that with this ETF, investors still get exposure to most of the big names in the stock market. At the end of August, the top five holdings were Nvidia, Apple, Microsoft, Meta Platforms, and Visa. Personally, I’ve invested directly in four out of those five companies because I believe they’re long-term winners that’ll outperform the market.

Now, a quality investing strategy isn’t going to outperform all the time. There will always be times where lower-quality stocks (cyclicals) have a period of strength.

Given that studies show that high-quality stocks tend to beat the market over time however, I reckon there’s a good chance it will deliver superior returns in the long run.

The AI revolution is just getting started

The other ETF I want to highlight is the L&G Artificial Intelligence UCITS ETF (LSE: AIAG). This is a product from Legal & General that’s focused on artificial intelligence (AI) stocks.

AI’s a huge theme today (and one I’m very bullish on) and this is reflected in this ETF’s recent performance figures. In US dollar terms, it gained 102.8% for the five-year period to the end of August. That’s significantly higher than the returns from the FTSE 100 and MSCI World indexes.

Given that the AI industry’s forecast to grow by around 30% a year between now and 2030, I believe there’s a good chance this product will continue to do well going forward. As always though, nothing’s guaranteed in the stock market.

This ETF’s higher-risk (Legal & General rates it a 7 out of 7 in terms of risk). That’s because it mainly owns tech stocks and these can be volatile at times. At the end of August, the top five holdings were Samsara, Palo Alto Networks, Cloudflare, ServiceNow, and Autodesk (Nvidia and Microsoft were in the top 10).

Taking a long-term view though, I think this ETF has the potential to deliver blockbuster gains.

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Diageo

What it does: Diageo manufactures and distributes premium drinks in nearly 180 countries. 

By Paul Summers. Since I’m wary of being overly invested in a small band of (very) highly valued tech stocks, I’d prioritise buying stakes in established companies with more attractive price tags. One example is premium drinks firm Diageo (LSE: DGE). 

Right now, the market hates this company. Shares have slumped back to lows hit during the pandemic as the cost-of-living crisis has hammered sales. There are also concerns that lower alcohol consumption in younger people could hamper growth going forward.

I think the drop is overdone. While alcohol consumption is falling, the world hasn’t suddenly turned teetotal. Moreover, Diageo is such a huge player that the odds are high that people will pick from its 200+ brands when they fancy a tipple. I also expect sales to recover as inflation continues to cool.

Meanwhile, a forecast price-to-earnings (P/E) ratio of 17 is significantly below the company’s five-year average of 24. 

Paul Summers has no position in Diageo.

L&G Artificial Intelligence UCITS ETF

What it does: L&G Artificial Intelligence UCITS ETF tracks a basket of companies that make significant revenues from AI.

By Royston Wild. It’s clear that the global artificial intelligence (AI) sector should experience spectacular growth over the next decade. Analysts at Statista think the market will show an annual growth rate of around 28.5% between now and 2030.

Predicting who will be the big winners at this early stage is a difficult task, however. Microsoft and Nvidia have (arguably) impressed the most so far. But will they still be at the front a decade from now?

Purchasing an exchange-traded fund (ETF) could be a profitable way for investors to exploit the AI boom while also hedging their bets. The L&G Artificial Intelligence UCITS ETF (LSE:AIAG) is one such instrument on my radar today.

The fund tracks the performance of 58 companies and has a significant weighting to the US, as you may expect. Prominent names include those two mentioned above alongside Alphabet, Darktrace and Palo Alto.

I also like this fund because its 0.49% management fee is one of the lowest in the business.

Remember, though, that while an ETF helps investors reduce risk, a fresh industry downturn could still pull its market value sharply lower.

Royston Wild does not own any of the shares mentioned above.

Scottish Mortgage Investment Trust

What it does: Scottish Mortgage is a UK-listed investment trust focusing on opportunities in growth-oriented sectors. 

By Dr James Fox. I’m actually pretty bullish on big tech and hold shares in two of the Magnificent Seven – Nvidia and Meta. So the UK stock I’d buy ahead of the Magnificent Seven is Scottish Mortgage Investment Trust (LSE:SMT).

The Baillie Gifford trust has a great track record of investing in the tech big winners of tech and currently has holdings in Nvidia, Amazon, Mercado Libre, and Tesla, among others. 

While I may not agree with all the trust’s holdings, with a team of analysts and no doubt a great model for picking stocks, I’m confident that the stock’s trajectory will be a positive one over the long run. 

It’s important to recognise that Scottish Mortgage has positions in unlisted stocks, and that can make valuations a challenge. After all, the stock market doesn’t value unlisted stocks. 

However, with its excellent track record, and exposure to growth-oriented companies, I’d buy Scottish Mortgage over Magnificent Seven right now.  

James Fox owns shares in Scottish Mortgage Investment Trust.

Scottish Mortgage Investment Trust 

What it does: Scottish Mortgage aims to invest in the world’s best growth companies across both public and private markets.  

By Ben McPoland. Right now, I’d rather invest in Scottish Mortgage Investment Trust (LSE: SMT) ahead of the Magnificent Seven stocks. Partly this is because over half of them are already in the FTSE 100 trust’s portfolio (Amazon, Meta, Nvidia and Tesla). So I’d get some exposure to the ongoing growth of these world-class businesses.

Moreover, as I write, I’d get to invest in the trust at a 9% discount to net asset value. This could be a cheaper and less risky way to invest in these mega-cap stocks.

I’d also gain exposure to the rest of the portfolio, offering diversification compared to buying the Magnificent Seven stocks individually.

Of course, this approach wouldn’t be risk-free. Around a third of Scottish Mortgage’s assets are in AI-related shares, notably in the semiconductor industry. Any sector-wide slowdown here could result in a sharp pullback in the share price.

Looking to the future though, the portfolio contains small companies that the managers think could one day become the next Magnificent Seven-type winners. These span emerging industries like quantum computing (PsiQuantum), lab-grown meat (Upside Foods) and carbon capture (Climeworks).

Ben McPoland owns shares in Tesla and Scottish Mortgage Investment Trust. 

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