The Case for Active Management in a Concentrated Market

I’ve been thinking a lot lately about what we actually own in our investments.

Not what we think we own. What we actually own.

The 10 largest companies in the S&P 500 now make up approximately 40% of the index. That is a level of concentration we haven’t seen since the mid-1960s.

Semiconductor-related companies are approaching 20% of the entire index.

Overseas, it’s even more extreme. Three companies, including TSMC, Samsung, and SK Hynix, account for approximately 30% of the MSCI Emerging Markets Index.

Three companies. 30%!

That’s your “diversified” emerging markets fund.

If you own a broad index fund, you own that concentration whether you intended to or not.

I’d like to give credit where it’s due. Martin Romo, Chief Investment Officer at Capital Group, recently wrote about this phenomenon, and it got me thinking. It’s worth a read if you have a few minutes. What follows is where I land on the issue.

Let me be clear up front: this is not an anti-AI rant. If you’re a regular reader of my blog, you’d know I use it almost every single day and am genuinely excited about where it’s going.

Many of the companies leading this market are extraordinary businesses. Real earnings. Real moats. Real demand.

The question isn’t whether they’re good companies. They are. The question is how much of your portfolio is quietly betting that one story keeps working exactly as expected.

At today’s prices and today’s weights, buying the index means placing an unusually large bet on a relatively short list of names.

Markets do this periodically. A shiny new idea emerges, the story is genuinely compelling, and money crowds into the handful of companies that represent it best. Sometimes the story pans out. And sometimes it pans out but the stock price already reflected it. And sometimes the real profits end up somewhere nobody was even watching.

Two numbers I keep coming back to…

Energy stocks were roughly 25–30% of the S&P 500 around 1980. Today, they’re around 3%.

Japan reached 44% of the MSCI World Index at the height of its bubble in the late 1980s. Today, it sits near 5%.

Neither situation maps perfectly to today, and I want to be careful here. A high concentration number tells you nothing about when anything will change. Narrow markets can continue running for years.

What history does tell you is that today’s biggest names have a poor record of remaining the biggest names 20 years later. That pattern repeats.

Here’s what actually bothers me about pure indexing at a moment like this.

An index fund doesn’t ask questions. It has no opinion on whether a stock is expensive, or, in some cases, even profitable. It doesn’t notice when a business starts losing ground to a competitor. It never stops to ask whether you’re being adequately compensated for the risk you’re taking on.

It buys more of whatever just went up because that’s the rule.

Somewhere along the way, index funds became the assumed “safe” choice. I understand why. They’re cheap, they’re simple, and for a long stretch, they’ve been difficult to beat.

But cheap and simple is absolutely not the same thing as safe.

An index has no judgment built into it. It can’t tell you that a sector has become frothy or that one of its holdings is quietly falling apart.

Indexing now accounts for more than half of U.S. fund assets. Which means the pool of investors doing the unglamorous work of comparing price to value continues to shrink.

That work is what helps set prices in the first place.

Index funds free-ride on it by design.

Active managers have one thing passive strategies don’t: the ability to change our minds.

We can trim, add, or walk away as the facts change. Nothing forces us to buy more of a company simply because it got bigger last quarter.

So no, the goal isn’t to avoid the AI winners. We should own them when the fundamentals truly justify it. And my firm does own many of them.

But we see the opportunity set as wider than the obvious names. Plenty of businesses will become more profitable by using these tools without ever being labeled an “AI stock.” Some of them are in industries you’d never associate with the theme.

Then there’s the part nobody writes headlines about: how much you own.

Position sizing is where much of the damage in a portfolio actually happens. One good idea should never be large enough to determine your outcome by itself.

Clients don’t pay us to copy an index. They pay us to think.

Sometimes that means a portfolio that looks nothing like the benchmark, which is not a comfortable place to sit while a narrow market keeps grinding higher.

That discomfort is part of the actual product.

Anyone can buy the index. What you’re paying an active manager for is the willingness to hold a different opinion when the evidence supports one—and the discipline to keep sizing positions as though the future is uncertain, because it is.

Here’s where I land.

Own the great businesses. Trust the research. Then hold that conviction loosely enough to admit you don’t know which of these companies will still be on top in 15 years, because the honest answer is that nobody does.

Conviction and humility, at the same time. That’s the whole job.

If you owned an index fund and the top 10 holdings were 40% of it, would you have signed up for that on purpose?

GO BACK TO INSPIRED INVESTING HOMEPAGE

Austin Wilson is a Partner and Chief Investment Officer at Hixon Zuercher Capital Management, a Registered investment Advisor in Findlay, Ohio managing over $500+ million assets under management.

Disclaimer: The views expressed in this blog are solely those of Austin Wilson and do not necessarily reflect the views of Hixon Zuercher Capital Management. Hixon Zuercher Capital Management and its clients may hold positions in securities mentioned. Nothing in this blog constitutes investment advice or a recommendation to buy or sell any security. All investments involve risk, including possible loss of principal. Please consult your financial advisor to ensure any investment aligns with your objectives and risk tolerance. Indices are unmanaged and not directly investable. Any investment in securities, funds, or other financial instruments will involve costs and fees, including but not limited to fund expense ratios, management fees, and transaction costs. This content is provided for informational purposes only and is not intended to comply with the requirements of the Investment Advisers Act of 1940 or any other applicable securities laws. Past performance is not indicative of future results.