Monday, February 9, 2026
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Investment wisdom celebrates diversification as the cornerstone of prudent portfolio management. Yet investors increasingly face a paradox: portfolios appearing broadly diversified by company count yet dangerously concentrated by capital allocation.
The Magnificent Seven account for 34.3% of the S&P 500 as of February 2, 2026, nearly three times their 12.5% weight in 2016. The concentration extends further: the 10 largest companies now represent 40% of the index’s total market capitalisation, roughly double the 20% seen in 2015-2016. By year-end 2025, this top-10 weight reached 41%, exceeding levels seen during the 2000 technology bubble.
The S&P 500’s historical average yearly return of 11.9% over the last 20 years makes passive index investing appear compelling. Yet this performance masks a structural transformation fundamentally altering the risk profile investors assume.
The shift towards passive strategies has reshaped capital markets. Passively managed funds grew from 19% of US investment company assets in 2010 to 48% by 2023. This represents more than cost-saving, it fundamentally changes how capital flows through markets.
When substantial capital follows market-cap weighted indices mechanically, the largest companies receive disproportionate flows regardless of valuation, creating feedback loops that amplify concentration. Passive strategies by definition allocate more capital to companies whose prices have already risen, biasing markets toward overvaluation. The largest S&P 500 firms experience the highest returns and volatility following index flows, whilst the top 10 stocks now account for nearly half the index’s total volatility.
Traditional portfolio theory relies on low correlations between asset classes to reduce volatility. Yet these relationships prove neither stable nor reliable when investors need them most. Correlations between US and non-US stocks have significantly increased over the past decade. The stock-bond relationship, long considered foundational to balanced portfolios, shows fundamental instability driven by persistent inflation, policy action, and fiscal imbalances. When correlations converge during stress periods, diversification’s protective benefits diminish precisely when most needed.
The concentration within passive vehicles creates opportunities that active management can address. In 2025, roughly 42% of the S&P 500’s total return came from the Magnificent Seven, which delivered high-20% returns versus high-teens for the broader index. This performance dispersion suggests substantial opportunity for selective capital allocation.
Genuine diversification extends beyond holding more securities. It requires exposure to different return drivers, varied economic sensitivities, and uncorrelated risk factors. Emerging markets offer different growth dynamics and demographic trends.
Fixed income provides cash flow predictability and ballast during equity volatility. Commodities respond to inflationary pressures and supply constraints. Commercial property delivers rental income tied to different economic factors.
Currency exposure deserves consideration. A portfolio concentrated in US dollar-denominated assets carries implicit currency risk many investors fail to acknowledge. International equities have led gains recently, with a declining dollar boosting returns and potentially indicating structural relationship changes requiring evolved portfolio construction.
Active management allows dynamic adjustment to changing conditions, valuation extremes, and emerging risks. When concentration reaches extremes, reducing exposure to overvalued segments whilst increasing allocation to undervalued areas positions portfolios for eventual mean reversion. When correlations shift, rebalancing maintains intended risk profiles.
Passive index investing offers undeniable advantages: low costs, tax efficiency, and simplicity. Yet simplicity does not equal comprehensiveness. A purely passive approach provides market exposure without risk management, diversification by company count without consideration of concentration, and benchmark tracking without regard for valuation.
The conditions that drove passive outperformance over recent decades, exceptionally low interest rates and steady multiple expansion, show signs of changing. Portfolios investors believe diversified carry concentration risk they may not recognise.
Building resilient portfolios requires acknowledging uncomfortable truths. Market-cap weighted indices inherently overweight the most expensive securities. Correlations fluctuate, sometimes failing when needed most. Passive strategies cannot adapt to changing conditions, adjust for valuation extremes, or reduce concentrated risks.
True diversification demands thoughtful allocation across asset classes, geographies, and return drivers. It requires active decisions about risk exposures, regular rebalancing, and willingness to position portfolios differently from benchmark weights.
The old saying warns against placing all eggs in one basket. Perhaps the more relevant question today is whether investors recognise they’ve done precisely that whilst believing they held 500 baskets.
We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.
Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI.
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