The hidden concentration risk inside passive funds
Peter McGahan
Monday 1st June, 2026.
I COVERED diversification and concentration risk a couple of weeks back, but I wanted to cover how that is impacted in passive investing – ETF’S/TRACKERS.
Passive investing used to be cheap, dull, sensible, cardigan-like. While the active fund managers waved their colourful charts around and explained why this was the year for their underperforming genius to reappear, trackers simply got on with the job.
That cost revolution was good for investors. It dragged charges down, exposed many expensive active funds, and gave ordinary savers access to broad markets at prices that would have looked impossible a generation ago. So, let’s not start by throwing passive funds into the sea. That would be the usual investor nonsense: discover a risk, panic, then create a bigger one.
But there is a problem. Passive does not mean evenly diversified. It means you own what the index tells you to own.
Most popular trackers are market-cap weighted. The bigger the company, the bigger its place in the index. So, when a share price rises, that company becomes a larger part of the tracker. New money flowing into the fund buys more of it. The fund does not pause, stroke its chin, and ask whether the valuation now looks a little deranged. There is no analyst. No valuation discipline. No raised eyebrows.
That matters because some of the largest indices are now highly concentrated. One FTSE 100 factsheet showed the top 10 holdings at 49.19 per cent of the index at April 30, 2026. In other words, a “FTSE 100 tracker” is not 100 equal slices of British corporate life. It is roughly half in 10 companies, with a heavy lean towards banks, oil, pharmaceuticals, miners and a few global consumer giants.
The US is even more striking. Reuters reported that by mid-August 2025 the Magnificent Seven made up about 34 per cent of the S&P 500, with the top 10 stocks close to 40 per cent. The index may contain 500 companies, but the lived experience of owning it is increasingly driven by a handful of giant technology and AI-related firms.
That does not make those companies bad. Many are extraordinary businesses. The point is simpler: investors who think they own a broad, balanced, democratic spread of corporate America may actually own a very large bet on a small group of
expensive mega-caps. That may work beautifully on the way up. It may also hurt beautifully on the way down.
Academic work is beginning to catch up with what common sense suggests. Research published in The Review of Financial Studies found that flows into passive funds disproportionately raise the prices of the largest firms. Apollo’s 2024 paper argued that the rise of passive investing can reduce price elasticity, weaken market responsiveness, amplify price movements and increase concentration in dominant large-cap shares.
There is a second issue, and it appears when markets fall. If investors redeem from passive funds, the manager must sell what the index holds. In stress, that can mean selling the same large holdings across thousands of funds at the same time.
Again, this is not an argument that passive funds are bad. It is an argument that investors should stop treating the word “tracker” as a sedative.
The practical question is not: do I own passive funds? It is: what risks have I bought? A global tracker may already have a large US weighting. Add an S&P 500 tracker, a technology ETF and a global growth fund, and you may have bought Nvidia, Microsoft, Apple, Amazon, Alphabet and Meta four times over, each through a different wrapper. That is not diversification. That is karaoke diversification: lots of microphones, same song.
The same is true at home. A UK investor who owns a FTSE 100 tracker, a UK equity income fund and a high-dividend fund may think they have three holdings. Underneath, they may have the same banks, oil companies, tobacco stocks and drug makers repeated with minor variations.
So, what should passive investors do? First, keep the virtues: low cost, transparency, simplicity and discipline. Then add adult supervision. Read the top 10 holdings. Check the sector weights. Look across the whole portfolio, not each fund in isolation. Ask how much is in the US, how much in technology, how much in the top 10 shares, and how much would fall together if the same trade unwound.
Passive investing is a tool, not a religion. Used properly, it is valuable. Used blindly, it can give you concentration risk with a low annual charge.
I will be creating a guide to investing, so, if you would like a complimentary copy, please email info@wwfp.net. If you have a financial enquiry, please call 01872 222422.
Peter McGahan is the Chief Executive Officer of Independent Financial Adviser firm, Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.
