AI dominance sparks investor concern

The risk of overconcentration in artificial intelligence-linked stocks has become a concern for investors this year, leading many to adopt strategies that reduce exposure to the largest companies.

Equal-weight and capped index funds have become popular for investors with different risk reduction objectives.

Smaller stocks outperform as market broadens

By mid-August, the S&P 500 had returned about 14% year-to-date. Its equal-weight version delivered 16.15%, while the S&P SmallCap 600 rose nearly 24%. The difference shows a rally extending beyond the “Magnificent Seven”—the tech giants that drove much of the market’s gains in recent years.

Amit Pathak, head of U.S. equity product management for APAC at S&P Dow Jones Indices, explained the change. “What we have seen this year is that even though the huge Mag 7 names are part of the S&P 500, the index itself has underperformed other parts of the market,” he said. “It is not just the story of Mag 7, but a broad-based rally.”

Valuations contributed to the shift. In June, the S&P 500 traded at about 20 times its one-year forward price-to-earnings ratio. Mid-cap and small-cap indices traded at 14 to 15 times, offering lower-risk opportunities.

Pathak added that inflows into equal-weight indices have been strong, lifting smaller stocks. “Investors looking beyond market concentration have started paying more attention to smaller companies,” he said.

Diversification tools beyond the S&P 500

Investors managing risk have also used capped indices, which limit the weight of any single stock.

For Australian investors, Pathak recommended combining domestic and U.S. equities. The two markets balance each other, with Australia’s resource-heavy economy complementing the U.S. focus on tech and consumers.

The move toward diversification follows warnings that AI concentration could leave portfolios exposed if the sector declines. While large tech stocks remain dominant, smaller companies’ recent gains show investors are already adjusting.

The shift isn’t universal. Many funds still rely on market-cap-weighted indices, the standard for passive investing. Whether broader participation continues or the market returns to its top-heavy pattern remains uncertain.

Global trends also influence these strategies, as geopolitical tensions shape investment decisions.