- With US equities occupying such a prominent role in global equity benchmarks, how investors choose to build their US equity allocations can have a meaningful impact on portfolio outcomes. Understanding the exposures investors hold, how they may evolve and whether they remain aligned with investment objectives are therefore key considerations when constructing portfolios.
Against this backdrop, three points stand out: rising concentration within market-capitalisation-weighted indices; the tendency for market leadership to change over time; and the need to make intentional allocation decisions.
Looking beneath the index: Concentration risk is rising
Market-capitalisation-weighted indices size companies according to their market value, so the largest companies naturally rise to the top under a clear and transparent methodology. However, in concentrated markets, this same design can result in unintended exposures. Active management provides a different lever, allowing investors to size positions deliberately and manage risk according to a specific mandate.
As market-capitalisation-weighted indices have become increasingly concentrated over recent years, investors have grown more reliant on the performance of a relatively small number of companies. In the S&P 500 Index, the top 10 companies by market capitalisation represent over 40% of the index (Exhibit 1). While this has been beneficial during a period of strong mega-cap performance, it also increases exposure to company-specific and sector-specific risks.
Concentration is not just a single-stock story; it is also evident at the style and sector levels. Over the years, the US equity market has gravitated towards areas of innovation, with growth sectors such as technology increasingly dominating the S&P 500. In 2014, the broader technology sector, comprising information technology and communication services, represented just 22% of the index. Twelve years later, this figure has risen to 47%. As a result, the market-capitalisation-weighted S&P 500 has increasingly tilted towards a growth investment style.
For investors seeking greater balance, an active approach offers a way to assess opportunities across the broader investment universe rather than allocating capital solely according to market capitalisation, helping to reduce unintended risks.
Today’s leaders may not be tomorrow’s winners
An index-based approach captures today’s market leadership, but it cannot anticipate the conditions or emerging companies that may define the next decade. Active management can play a complementary role by looking beyond current market leadership.
History shows little overlap among the largest companies from one decade to the next. Today's market is increasingly dominated by technology and financial companies, but that leadership is unlikely to remain unchanged (Exhibit 2). For passive investors, this means portfolio exposure becomes increasingly concentrated in today’s market leaders, regardless of whether they continue to outperform.
As market leadership evolves, an investment approach focused on fundamentals can help identify opportunities beyond today’s largest companies, including businesses with the potential to become tomorrow’s winners. Elevated valuations also have implications for the return outlook. Over the next decade, our Long-Term Capital Market Assumptions (LTCMA)1 project a 6.7% return for US large-cap stocks, less than half the category’s annualised return over the past decade. Against this lower-return backdrop, investors may become increasingly reliant on alpha, rather than beta alone, to achieve their long-term return objectives, placing greater emphasis on manager selection and a disciplined investment process.
Passive and active investing are both active decisions
The active-versus passive debate can obscure a more fundamental portfolio-construction question: which approach is right for an investor’s objectives and holding period? Investors should also consider their investment philosophy to align portfolios with where they believe value can be found.
Generating alpha consistently is challenging, and not all active managers succeed. Over the past 30 calendar years, an average of 41% of active large-cap managers outperformed their benchmark in any given year.2 The question, therefore, is not simply whether outperformance is possible, but which structural characteristics may make it more repeatable.
Ultimately, long-term investment success continues to be driven by company fundamentals. Historically, earnings growth and dividends have been the primary drivers of long-term equity returns, while shorter-term performance has been more heavily influenced by price-to-earnings multiples, reflecting shifts in market sentiment and investor expectations (Exhibit 3).
These considerations have implications beyond the US equity allocation itself. US equities typically make up over 70% of a globally diversified portfolio's total equity allocation, so the quality of decisions made in the US market can have an outsized effect on total returns. Their effects can therefore compound across the whole portfolio.
The markers of a durable edge
If manager selection matters, the practical question is how investors should evaluate a manager. Historical performance alone is an insufficient guide; investors should also consider the structural characteristics that may help make successful outcomes repeatable rather than incidental. Three characteristics stand out:
- Research depth and analyst coverage: Breadth and depth of coverage determine how much of the opportunity set a manager can genuinely assess.
- Team-based culture and processes: Outcomes that depend on a single individual are fragile. Team-based processes with shared accountability tend to be more durable.
- Technology that accelerates outcomes: Data is only valuable if it reaches decision-makers efficiently and improves the speed and quality of their judgement.
J.P. Morgan Asset Management's investment process provides an example of how these characteristics can work in practice:
- Research depth and analyst coverage: $1.3 trillion in client assets under management with a $190 million annual research budget to invest, execute and deliver.3 132 dedicated career research analysts covering over 2,500 companies across four continents, with direct access to company management through 5,000 annual meetings.4
- Team-based culture and processes: Collaborative global conversations are created through the partnership model between research analysts and portfolio managers. We treat the research analyst role as a career position, not a stepping stone; thus, our analysts manage risk and are compensated based on their own sector-specific portfolios. Global sector teams also meet monthly to maintain connectivity across the globe. This structure cultivates more honest and curious conversations that drive our leading insights.
- Technology that accelerates outcomes: Spectrum (our investment platform) connects research, portfolio management and trading in a single platform, helping investment teams see more and act faster, particularly during periods of market volatility.
Ultimately, the value of these characteristics lies in the investment outcomes they can help support. Since 1997, our top-ranked companies have outperformed our bottom-ranked companies (Exhibit 4), providing evidence of the value our research process has added over time.
For investors, the broader lesson is that manager selection should go beyond past performance. Research depth, a durable team-based process and the effective use of technology can all help investors assess whether an investment approach has the potential to deliver repeatable long-term outcomes.