The problem with equity market concentration

All over there are signs of increasing equity market concentration. Country equity market indices are becoming increasingly concentrated, leading to a situation in which the indices are more reflective of the performance of regional champions or locally listed global champions than the performance of the local economies themselves.

For example, as of the end of January, the 10 largest US stocks accounted for 35% of the Bloomberg US large cap index. While that is sizeable, it is still much smaller than the UK (49%), Brazil (58%), France (62%), Germany (66%), South Africa (70%) and Switzerland (75%). Given the concentration risk in individual major equity indices, it is necessary to diversify across regions.
 

Date sampled: 12/02/2025
Source: Investec Wealth & Investment, Bloomberg

The US has been a special case. While the US has become increasingly concentrated, the US itself has become a much larger part of the global market. The net result is that the US now accounts for 70% of developed market equities.
 

Date sampled: 12/02/2025
Source: Investec Wealth & Investment, Bloomberg

The US tech sector alone has a larger market cap than the entire European market according to research house BCA Research – a situation unseen even in the height of the dot com bubble.
 

Source: BCA Research, February 2025

Country indices are now in effect concentrated bets on a few large counters and even the global index is now largely a bet on the US. But does this matter? There is an argument that winners should be allowed to run and that concentration is just the result of the success of a selection of equities. However, there are two key issues with this thinking, which we discuss below.

1. The US is not cheap

The US equity market trades on a forward price/earnings multiple of 23, a 35% premium to the 15-year median. There may well be opportunities outside of the US, and even within the US if smaller companies are considered.  From an index perspective though, that does not matter. The global developed market index is now 70% made up of a market (the US) that is concentrated and which trades at a 35% premium to its history.
 

Date sampled: 12/02/2025
Source: Investec Wealth & Investment, Bloomberg

2. Company-specific risk becomes more of an issue

Not only has company-specific risk become more of an issue, but the 'Magnificent 7' (Apple, Alphabet, Amazon, Meta, Microsoft, Nvidia and Tesla) all share the same characteristic – they are all growth, technology stocks. There is therefore an increasing amount riding on a particular style bet paying off.

Date sampled: 13/02/2025
Source: Investec Wealth & Investment, Bloomberg

A problem for active managers

Global markets have become concentrated through the strong performance of a set of large counters. This makes it difficult for active managers to outperform – the primary reason for this is that it is hard to hold an overweight position in something that is already a large part of the index. The flip side holds true though. When large caps underperform, we would expect active managers to outperform. This is borne out by research by Morgan Stanley.

So what does this mean for investors? Investors should brace for volatility. The rising influence of individual companies on the global market opens the door to greater volatility, as big moves in these counters lead to big moves in indices.

How can investors mitigate against this? There are several steps investors can take to deal with rising concentration risk.

For a start, it’s no longer reasonable to expect a single country index to provide diversified exposure. Even the US market is now heavily reliant on a handful of counters. It is necessary to diversify across-country exposure to get diversified equity exposure.

Given the very large weight of the US in global equities, it’s increasingly important to diversify across asset classes. The global equity market is now largely a play on the direction of the US equity market – a diversified multi-asset portfolio should go some way in reducing the overwhelming influence of US equities, which are currently expensive.

The key takeaway is that an active effort to diversify risk is required in the current market conditions. Relying on country indices to achieve this has become a risky proposition.