Implications of Increased Index Concentration for Active Investors

Abstract

This short article examines the implications of the rise of mega tech stocks for active portfolio management. We show that smart beta factor indices take big over-and underweights in mega caps that can make or break their performance. As a result, one can wonder if factor risk is still the main driver of their performance, or if they mostly expose investors to idiosyncratic risk nowadays. By contrast, we argue that the performance of diversified factor strategies with tracking error management is largely unaffected by increased index concentration. We conclude that although no active strategy is completely immune to the effects of increased index concentration, the effects can be largely mitigated with proper risk control. This is vital to prevent active management from degenerating into a binary bet on the fortunes of a few magnificent tech stocks.

Keywords: Active management, Portfolio management, Index concentration, Tracking error, Risk management