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As Equity Indexes Become More Concentrated, Is Risk Growing for Investors?

Johara Farhadieh portrait photo

 

   By Johara Farhadieh
   Chief Investment Officer

Joe Halwax portrait photo

   By Joe Halwax, CAIA, CIMA
   Senior Managing Director, Institutional Investment Services

 


March 24, 2025

We wouldn’t fault readers if they rolled their eyes a bit at another investment-focused article centered on the “Magnificent 7.” It certainly feels like this group of stocks—the seven U.S. mega-cap technology names which have sharply outpaced the rest of the S&P 500 since early 2023—have dominated nearly every investor conversation for the past several years.

But bear with us—today, we’re taking a different approach to the Magnificent 7 discourse by looking at how the trend has impacted specific market mechanics, namely the concentration of these select names in equity indexes.

Annual Returns Since 2021 (Through February 28, 2025)

Annual-Returns-Since-2021

(Source: J.P. Morgan Asset Management)

How Concentration Works

As the U.S. mega-cap names have outperformed the broader market, their market capitalization (or “market cap”)—defined as the total value of a publicly traded company's outstanding common shares owned by stockholders—has increased. As a reminder, the majority of U.S. equity indexes are “market cap weighted,” while a smaller number are “equal weighted.”

Market Cap Weighted: The higher the market value of a company, the larger weighting that company has in the index. In other words, larger companies represent a higher proportion of the index.

Equal Weighted: As it sounds, an equal weighted index will hold all the stocks in the index at the same percentage or weighting.

So, as the mega-cap names have increased in market cap, their weighting in many investors’ indexes, such as the S&P 500, have also increased. This means an investor that owns an S&P 500 index fund now owns more of the large names—and less of the remaining companies. Here’s an example of how that works compared to an equal-weighted index:

equal-weighted-index

This example highlights two specific names that are held in sharply different weights when looking at a market cap weighted index versus an equal weighted index.

Turning to sectors, we can see that, over the past year, the S&P 500 equal weighted index held on average 18% less in Information Technology (Ex: Nvidia, Apple, Microsoft) and 5% less in Communication Services (Ex: Google, Meta, Netflix) versus the more popular cap-weighted S&P 500 index.

Average Weight Difference Over Past Year (Equal Weighted S&P 500 vs. S&P 500)

Average-Weight-Difference

(Source: S&P Global, as of January 31, 2025)

Since 2021, and especially in 2023 and 2024, the top 10 names in the S&P 500 have outpaced the returns of the other 490 stocks. As a result, they have made up an increasingly large portion of the index—and are now at the highest level of concentration (36.4% of the total index) since the 1950s and 60s.

Weight of the Top 10 Stocks in the S&P 500

Weight-of-the-Top-10-Stocks

(Source: J.P. Morgan Asset Management)

Does Concentration Lead to More Risk for Investors?

Whether or not the concentration trend is a cause for concern for investors—particularly those holding index funds—has become the subject of some debate.

The arguments that increased concentration heightens the risk of holding the index are straightforward:

  • With the likes of Apple and Nvidia constituting 7% and 6.5% of the S&P 500, respectively, index fund investors are prone to heightened idiosyncratic or “single name” risk.
  • Roughly a third of the S&P 500 is represented by the Magnificent 7, and another 12% is in the technology sector. Nearly half of the index is now driven by technology and the recent focus on artificial intelligence. This trend could be impacted if the anticipated efficiencies and profits from AI do not meet high expectations, or if non-U.S. competitors like DeepSeek can capture market share.
  • The price-to-earnings valuations of the top names in the S&P 500 are historically high. If the earnings reports of these large companies start to disappoint, the market could react harshly.
  • Many investors use risk and performance models that are based on past data, when indexes were far less concentrated. These models may be less reliable in 2025.

There are also good arguments that the risk from concentration is overstated:

  • The last time we saw similar levels of concentration in the 1950s and 60s, market returns were strong.
  • According to Bridgewater, “historically, there has also been no sustained outperformance or underperformance for the largest seven companies versus the rest of the S&P 500.”
  • Market cap weighted indexes are designed to reflect that companies becoming more valuable have a higher weight in the index. This is a feature, not a bug.
  • Over the past 10 years, the S&P 500 ranks in the 12th percentile in eVestment, meaning it has outperformed 88% of active funds.
  • One perspective is that active managers try to “fix” the problem of over-concentration but have historically failed to do so.

Still, in the 1950s and 1960s, when markets saw similar concentration, passive investing was nonexistent, unlike today, where it accounts for a significant share of the U.S market. The market microstructure has changed, resulting in less liquidity due to the significant weights of these top names in popular U.S. indexes. This is beneficial when the market is rallying, but problematic during downturns, as there are fewer active managers to step in and buy. The August 2024 volatility in equities, influenced by the Yen carry trade move, and the recent tariff volatility, may be previews of the next major drawdown.

One final consideration is that while concentration risk is higher, it is just one of many risks investors need to consider. Other risks include:

  1. Higher for longer U.S. interest rates
  2. New administration and economic policies (e.g., tariffs)
  3. Lofty earnings expectations
  4. Historically high stock valuations
  5. Any slowdown in U.S. share buybacks

We agree that the past several years of higher concentration have made passive investing riskier. This increased risk is certainly worth monitoring, and using active management or different indexes to help mitigate it might be worth considering. However, we stop short of calling this concentration a critical risk right now, highlighting that the S&P 500 index has outperformed 88% of active funds over a 10-year period. Wespath builds custom portfolios for institutional clients with both active and passive investments based on your needs and risk tolerance. Let’s discuss your portfolio construction and risk management.