The debate over index concentration
The meteoric rise of US mega-cap technology stocks over the past 15 years or so has led to an extraordinary level of index concentration. The combined weight of the five largest stocks in the MSCI World Index has surged from around 6% in 2015 to 20% today, while the top 10 stocks now make up 25%, up from 10% a decade ago.
At first glance, this might not seem problematic. After all, these stocks – known by various nicknames and acronyms over the years, such as the Magnificent Seven or Mag 7 – have delivered extraordinary returns.
However, such high levels of concentration can have profound implications, particularly for active investors. A key challenge is to the principle of diversification, which is the cornerstone of many investment strategies. Investing in market-cap-weighted indices also channels capital into stocks with the highest valuations – often running counter to value-oriented approaches and leaving investors highly exposed to negative surprises in these stocks. Investors face a dilemma: follow the trend and embrace concentration risk, or diversify and risk underperforming relative to benchmark indices.
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Smart beta
Among the active strategies most affected by the concentration issue are “factor”-oriented “smart beta” strategies, which aim to enhance returns by targeting factors that are thought to drive performance, such as value, momentum, quality, and volatility (where low volatility is the goal).
Research by Robeco highlights how factor-oriented (in particular single-factor) strategies that fail to account for concentration risk may end up exposed to idiosyncratic risk rather than genuine factor premiums. Robeco analyzed the MSCI World Quality, Momentum, and Minimum Volatility indices over the seven-year period from 2018 to 2024. The quality and momentum indices outperformed the overall market by around 50% and 30%, respectively. However, over 60% of the quality index outperformance is attributed to Mag 7, and over 50% for the momentum index. The minimum volatility index, on the other hand, underperformed by 55%, as its methodology largely ignored these mega-cap stocks.
The solution, according to Robeco, is to engage in multi-factor strategies with tracking error management – specifically, enhanced indexing portfolios that combine large numbers of small overweight positions in stocks with attractive factor characteristics with large numbers of small underweight positions in unattractive stocks. By limiting the active position in each individual stock, the idiosyncratic (or unsystematic) risk of the portfolio is contained.
The other side
Not everyone agrees that passive investing is exacerbating concentration risk. Writing for the Financial Times late last year, Robin Wigglesworth challenged the assumption that passive flows into index-tracking funds are distorting market structure, citing Goldman Sachs research. Goldman argues that index concentration is largely a reflection of underlying fundamentals – companies that dominate indices do so because they are highly profitable and innovative, not simply because they receive passive fund inflows. Moreover, passive funds continuously rebalance, meaning they do not blindly amplify market trends in the way some critics suggest.
Market performance in 2025: Shift in leadership
Market dynamics so far in 2025 have been interesting. US stocks – heavily favored at the start of the year – have notably underperformed, led by mega-cap tech (down for the year), while Europe, China, and emerging markets have seen strong absolute and relative gains.
This reversal may well be an effect of index concentration – US tech stocks had become overcrowded, while many international markets were consensus underweights. On the other hand, such rotations are nothing new – swings and overshoots in investor positioning and sentiment have always been a feature of financial markets. The key is to isolate the impact of newer drivers, such as the rise of passive investing, from more constant factors like investor sentiment. The strong arguments on both sides of the debate suggest that it is far from resolved.
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