- Head of Multi-Asset Strategy
United States, Institutional
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While the Magnificent Seven stocks have struggled through the first few months of 2025, it seems too soon to declare that we’ve passed “peak market concentration.” To offer some perspective on this era of tech leadership, Head of Multi-Asset Strategy Adam Berger and Global Equity Strategist Andy Heiskell discussed the challenges posed by narrow markets, how the current environment compares to previous examples, and strategies asset owners should consider, such as extension (130/30 or 140/40) and index-completion strategies.
Adam: Market concentration still comes up in just about every client meeting I have. Can you put the challenge in context from the standpoint of active equity managers?
Andy: Sure, let’s start with a few numbers. Currently, the top 10 stocks in the S&P 500 make up about 36% of the index and the top 10 stocks in the MSCI All Country World Index (ACWI) make up about 23% of the index. That level of concentration has an enormous impact on the rest of the benchmark: Almost two-thirds of stocks in the S&P 500 had an index weight of less than 10 basis points (Figure 1). And more than 80% of stocks in the ACWI had an index weight of less than 10 basis points.
Figure 1
So, it's really an issue of portfolio construction. Most active managers think about their portfolio as a diversified set of investments designed to achieve an attractive risk-adjusted return. But if the index looks like Figure 1, it's almost impossible to create a portfolio that is both in line with the index on a relative basis and also providing diversification. This is most obvious in mutual funds that have legal requirements around diversification — the indices may be so top-heavy that managers are prohibited from holding index-weight positions in many of these mega-cap stocks. And more broadly, managers who like the bigger benchmark names may find that holding them leaves less room for their other high-conviction names.
Adam: There have been previous periods of market concentration. How is this one different?
Andy: We've seen periods of extreme index concentration, but it hasn’t reached this level since the late 1960s and early 1970s (Figure 2). To me, the big difference between today’s narrow market and previous ones is the nature of the companies leading the market: These are exceptional tech companies that have been dominating the market and increasingly dominating our lives. And that’s led to fundamentally driven excess returns. This is about strong growth in profits and free cash flow, return on invested capital, and capital return to investors. In other words, there have been very rational reasons for the recent market leadership, unlike in some prior periods.
Figure 2
Another difference in the current environment is that we’re seeing concentration not just at the individual stock level but also at the sector, style, and factor levels. In the late 1960s and early 1970s, markets were concentrated in a limited number of stocks, but those stocks were widely diversified by sector. Think of companies like GE, GM, Exxon, AT&T, Kodak, and IBM. Today’s leaders have a strong bent toward technology and growth.
Adam: As I noted, we’ve actually seen some of the mega-cap tech companies lag the market to begin 2025. With that said, do you expect this current period of concentration to continue, or could we begin to see some meaningful broadening?
Andy: I think this concentration could persist as long as those exceptional fundamentals that I mentioned persist. At a basic level, relative price and returns follow relative growth of profits and free cash flow over time. One question I often get is, “Can the mega-cap tech companies continue to grow faster than average?” Over short periods, that’s certainly possible. Over the longer term, though, the mathematics of averages will catch up with them.
A related factor is investor expectations. Over the last couple of years, the mega-cap tech companies have consistently exceeded current expectations, while future expectations have continued to ratchet higher. Interestingly, however, Q4 2024 was the first period over the past two years in which their results stayed mostly in line with expectations — in other words, they didn’t exceed expectations. And forward consensus expectations did not change after Q4. So it may be that investor expectations have finally caught up with the fundamentals.
Of course, most investors would welcome some broadening of growth across the rest of the equity market. It’s stunning to think that over the past two years, the earnings growth of the entire US equity market was driven by just seven companies. But we’re starting to see some positive signs in this respect. In Q4, the S&P 500 ex the Mag Seven delivered EPS growth of 7%. And when I talk to allocators, there’s a growing recognition that this exceptionalism around the mega-cap tech stocks is feeling a little long in the tooth. Maybe it can continue for a bit longer, but it may not be too early to be looking more broadly for opportunities on the other side.
Adam: Are there any takeaways from prior periods of market concentration that indicate how conditions might reverse?
Andy: It's a mixed bag. As I noted, market leadership during the late 1960s and early 1970s period was much more diversified than the current period, so the ways in which it unwound were varied, including regulatory and competitive forces and technological change. The late 1990s may be a better point of comparison, as the market was heavily driven by technological innovation amid the internet boom. The market leaders at the time were, in many cases, not the companies that ultimately succeeded. In an era of innovation, the long-term winners might only be in their infancy or may not even yet exist. It’s also worth remembering that if the technology is really a game changer, the impact will eventually be felt broadly in terms of economic productivity and market returns.
Adam: So, looking back on this latest period of market concentration, what are some of the takeaways or lessons asset owners should be thinking about?
Andy: From a practical risk-management perspective, one of the big takeaways is that active managers need to be just as aware of their active underweights as their active overweights. That’s especially important in a very narrow market: If a manager is underweight a stock by 300 basis points, there should be the same level of conviction in that position as there would be in one with an overweight of 300 basis points.
I also think asset owners should be taking a fresh look at portfolio diversification. The saying goes that the only free lunch in investing is diversification, but in recent years, that’s a meal that has induced a lot of indigestion. Holding almost anything other than mega-cap tech has been a drag on returns and added to risk and volatility. That said, I think we're moving back into an environment where diversification matters. We’re seeing less synchronization of cycles across economies, making it more important to understand the level of diversification across a portfolio. That requires thinking not just about direct exposure to the mega-cap stocks, but also the “thematic” exposure to those stocks. When the DeepSeek news broke earlier this year, it wasn’t just Nvidia that took a hit. There was a big drawdown in data-center stocks and others tied to the AI trade. So, it’s important to understand correlations across exposures and what that means for overall diversification.
Interestingly, while we've had this very narrow market, the past five years have also brought a sharp increase in equity market dispersion — a measure of the range of outcomes between the winners and losers. It’s been evident across individual stocks globally, but also between and within sectors. This is attractive for active managers who can identify those winners and losers, and I think it helps explain why we have seen improved performance from long/short managers, including traditional hedge funds and extension (130/30 or 140/40) approaches.
Adam: Can you talk a bit more about extension strategies and any other portfolio ideas you think asset owners should consider?
Andy: Extension strategies are at the top of my list when it comes to navigating narrow markets. Being able to express an active view through both long and short investments can provide valuable flexibility when the market is as concentrated as what we see in Figure 1. For a long-only manager, it's hard to express an active underweight with a stock that has a single-digit basis point weight in the index. But extension strategies can address this by using short exposure to fund more long exposure. This gives the manager more flexibility to own the largest benchmark names at a market-cap weight if they do not have a differentiated view on the companies, while still allowing them to be highly active in the remainder of their opportunity set.
I also think asset owners might want to consider “index completion” approaches that use passive allocations to big benchmark weights to essentially neutralize them — helping to hedge the risk of being underweight the big names and put the focus on the managers’ high-conviction stock-selection ideas.
Asset allocation implications
Adam: Let me offer a few closing thoughts on market concentration:
Focus on the change in concentration more than the level — As I discussed in a recent article, we’ve found that periods of rising market concentration are particularly challenging for active managers. If concentration remains high but fairly steady, as it did for an extended period in the 1960s and 70s, there can still be ample room for active managers to add value.
Don’t try to time a reversal in concentration — As Andy noted, there are some signs of broadening in the market, but several forces — including the momentum behind technology innovation — could drive continued concentration for an extended period. Rather than invest time trying to call the moment when this unwinds, I would focus on preparing a portfolio for a range of outcomes.
Review active allocations — To pick up on Andy’s point about active management, it’s not just what you own but what you don't own — the overweights and the underweights. So, take the time to understand how much risk a portfolio has from mega-cap underweights. I also think allocators may want to focus less on maximizing the level of active risk in a portfolio (higher tracking risk) and more on taking higher-quality active risk (higher idiosyncratic risk). This may be where those extension strategies or index completion strategies come in, creating opportunities to gain exposure to a manager's best ideas.
Review beta exposure — Given the increased concentration in the US market and how the US share of the global market has ballooned as a result (from half to roughly two-thirds of all global market cap), consider other opportunities to improve diversification. Is there room to add an overweight to non-US, emerging market, or small-cap stocks, for example? Of course, investors need to bear in mind the amount of risk they are taking with any such shifts, given the possibility that concentration persists.
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