When Indexes Stop Being Diversified

Every investor has seen the pie chart. Slice a portfolio into neat wedges — 60% stocks, 40% bonds, or some more elaborate breakdown of large-cap, small-cap, international, and emerging markets — and the assumption is that the “perfect” combination will manage risk and return through any environment. It’s a comforting idea. It’s also increasingly disconnected from what’s actually inside those wedges.

Today, most of those allocations are implemented through passive indexes or proprietary funds that hug an index closely enough to be “closet-indexed.” That’s a problem when the indexes themselves have become dangerously concentrated.

Consider the numbers. As of June 30, 2026, the top 10 holdings of the S&P 500^® Index made up 41% of the entire index, according to Morningstar. Zoom into the S&P 500 Growth Index and that concentration jumps to 62% in just ten names. Even the MSCI Emerging Markets Index — an index meant to represent economic growth across dozens of countries — has 39% of its value riding on ten companies, with Taiwan Semiconductor alone accounting for 14%.

Source: Morningstar. Data as of June 30, 2026.

Top 10 holdings as a share of index value: S&P 500, S&P 500 Growth, and MSCI Emerging Markets
Source: Morningstar. Data as of June 30, 2026. Top 10% total may not add up due to rounding.

That means “diversifying” into large-cap growth, or into emerging markets, increasingly means making a concentrated bet on a handful of technology and semiconductor names — NVIDIA, Apple, Alphabet, Microsoft, Taiwan Semiconductor — regardless of the label on the fund.

When indexes stop representing asset classes

The pie chart assumes each slice behaves differently enough from the others to smooth out the ride. But when the “large-cap growth” slice and the “emerging markets” slice are both quietly dominated by the same handful of technology and semiconductor stocks, that assumption breaks down. Portfolios that look diversified on paper can end up moving together, driven by the fortunes of a small group of mega-cap companies.

This isn’t a new observation, but the degree of concentration has become more extreme. We flagged this dynamic building back in March, and it’s only intensified since. We’ve also written about how market leadership is rotating away from the “just own the S&P 500” playbook that worked so well for so long. Concentration risk is the flip side of that same coin: the more markets rotate around a narrow set of winners, the less a broad index actually diversifies you.

What we’re doing about it

We think there are three practical responses to an environment where indexes no longer reliably represent the asset classes they’re named for.

First, independent manager selection matters more, not less. As passive indexes drift toward yesterday’s winners, active managers can intentionally step away from concentrated exposure. They also add a layer of diversification simply because investment approaches vary meaningfully from manager to manager — two active funds in the same asset class can behave very differently from each other, which is exactly the kind of dispersion a concentrated index can no longer offer.

Second, strategy diversification deserves as much attention as asset class exposure. Many proprietary mutual funds and ETFs exist mainly to fill a slot in an allocation pie chart, which means they drift alongside the same concentrated indexes. Managers running genuinely distinct, fundamentals-driven strategies are less tethered to benchmark construction and can provide real diversification when indexes stumble.

Third, we treat manager selection as a risk management decision, not just a return-seeking one. We prioritize funds built to manage downside risk and to perform relatively well during periods of market disruption or structural change — the moments when concentrated indexes are most exposed.

As Heraclitus put it, “no man ever steps in the same river twice.” The market environment that made simple index investing look easy is not a permanent feature of markets — it’s a snapshot of one particular river at one particular moment. If the purpose of asset allocation is to manage risk and grow portfolios through multiple market environments, today’s index concentration presents a sharp turn in that river. Just as the popularity of indexing has never been greater, differentiated positioning from active managers has arguably never been more important.