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Concentration Risk in a Handful of Index Giants
Key takeaways
- Capitalisation-weighted indices like the S&P 500 automatically assign greater weight to the largest companies.
- Historically the top 10 companies held 15–20% of index weight; today it can be significantly more.
- Concentration is not a problem in itself — as long as the largest companies keep growing, they pull the index upward.
- The problem arises if a rotation out of mega-caps occurs and ETF investors are forced to buy into the dip.
- Alternatives: equal-weight indices or a combination of regional ETFs for your own balancing.
Modern capitalisation-weighted indices are inherently concentrated — the better a company performs, the greater its weight in the index, and investors in an ETF cannot influence this.
How capitalisation weighting works
A capitalisation-weighted index assigns each company a weight corresponding to its market capitalisation. A company worth CZK 3 trillion has three times the weight of a company worth CZK 1 trillion. As a result, a handful of the largest companies can represent a very substantial proportion of the entire index.
Why growing concentration has occurred
- Technology platforms exhibit network effects and winner-takes-most dynamics — the largest grow fastest.
- Passive investing itself reinforces the largest companies: every new dollar into an index ETF buys everything in proportion to weight.
- Share buybacks reduce the number of shares in circulation and push prices up.
When concentration is a problem and when it is not
If mega-cap companies keep delivering results and innovating, index concentration is not a problem — they pull it upward. The problem arises at the moment of rotation: investors shift capital from premium-valued technology into value or defensive sectors. Index ETFs then have to sell the expensive and buy the cheap, but in practice this happens slowly and with a lag.
Alternatives to reduce concentration
- Equal-weight ETF: each company has the same weight regardless of market cap. Historically exhibits a different risk profile from the market-cap-weighted index.
- Combination of regional ETFs: separate allocations to the US, Europe, and emerging markets give greater control over regional concentration.
- Small-cap addition: adding a small-cap ETF reduces dependence on mega-caps and adds variety.
For most investors, a simple All-World or S&P 500 ETF remains a sensible choice — but it is good to know what you are actually holding. A more detailed view of the composition is offered by the ETF navigator.
FAQ
Why are indices like the S&P 500 so concentrated?
Capitalisation weighting means the largest companies carry the greatest weight. The better they perform, the larger they grow and the greater their weighting. Passive inflows into index ETFs amplify this effect further.
Is it dangerous to invest in a concentrated index?
Not necessarily dangerous, but it means that index performance depends heavily on a handful of companies. When they do well, the portfolio rises quickly. If a rotation occurs, the drawdown may be more concentrated than the number of holdings would suggest.
How can I reduce concentration risk in an index?
An equal-weight ETF, a combination of regional funds, or adding a small-cap ETF are ways to spread exposure beyond mega-cap companies. For most investors, however, a standard global index still represents an acceptable trade-off.