The CEO of the world's largest index provider asserts that diversification is still the key to success in the face of shifting market dynamics.

• On Wednesday, Dan Draper, CEO of S&P Dow Jones Indices, stated on CNBC's "Squawk Box Europe" that traders are shifting their strategies by investing in small caps and defensive sectors.
• He stated that investors are seeking to purchase an equal weight index instead of the market cap-weighted S&P 500 with a focus on specific stocks.

The head of the world's largest index provider believes that diversification into smaller stocks is a "free lunch" for long-term investors as market trends shift.

Traders are shifting their focus from the "Magnificent Seven" mega-cap tech stocks to small caps and defensive sectors, as advised by Dan Draper, CEO of S&P Dow Jones Indices, in a recent interview with CNBC's "Squawk Box Europe."

Rather than buying the market cap-weighted index with a concentration, investors are seeking an equal-weight index that assigns the same weight to every stock regardless of market size.

Draper stated that an equal weight approach favors smaller companies, value, and more defensive stocks, and that this strategy has been observed in both the cash equity market and derivatives, including the E-Mini futures contract on the equal weight.

"We have observed that diversification has been beneficial, as seen in July when U.S. inflation numbers were released and small caps outperformed. Additionally, defensive sectors have shown value. This presents an opportunity to diversify away from concentration."

In August, investors are grappling with volatile global stock markets, fluctuating expectations for Federal Reserve rate cuts, and the ripple effect of the Japanese yen carry trade on other assets.

Draper stated that when considering potential rate cycle changes in the U.S. and Japan, it's important to recognize the direction of money in motion. However, the mean reversion is crucial.

When assets experience a sudden shift, they often return to their long-term average over time.

As a long-term investor, diversification is your "free lunch," allowing you to become more defensive or interest rate-sensitive, as factors that had previously lagged are now starting to come into play.

Small- to mid-cap stocks present a potential opportunity for market participants as wider market forces shift.

Craig Johnson, chief market technician at Piper Sandler, stated on CNBC's "Worldwide Exchange" on Thursday that the odds of a U.S. recession have increased, and at the time when a recession is announced, it is often already over and completed. Additionally, small- and mid-cap stocks tend to perform well during this period.

"I believe that it would suit well into the upcoming Fed cuts in September. It's time to closely examine small- and mid-cap stocks," he stated.