Passive is an active choice

Passive investing is an active governance decision. For different investors, at different times, passive investing may or may not be the right decision. But it is always a decision, a commitment by an investor that tilts the outcome towards certain possibilities more than others.

Investors should always understand what they are buying, including when they do something so apparently simple as tracking an index. Index trackers may be exposed to unforeseen risks, which did not exist, or which were lower, only a few years ago.

Over recent years, major equity indices such as the MSCI World Index have become highly concentrated. They have become heavily weighted towards the largest stocks, especially technology stocks. Investors who track market-capitalisation (cap) weighted indices are putting more of their money into those mega caps, or superstar firms, than ever before. Whether or not that is the correct strategy is a question that should be addressed and consciously decided upon by the investor – it is an active choice. Investors should not blindly follow a concentrated strategy, allowing diversification to take a back seat.

Over recent years, market cap weighted indices have done well. For example, as at 10 June 2026, the MSCI World Net Total Return USD Index, a market cap index, had returned 119% since 31 December 2019, outperforming the MSCI World Equal Weighted Net Total Return Index, which returned 70% over the same period. The Equal Weighted includes the same constituents, but at each quarterly rebalance date, they are all weighted equally, effectively removing the influence of each constituent’s current free-float market cap on its weight. With a market-cap-weighted index, more of an investor’s capital is allocated to securities whose free-float market capitalisations are largest; all else equal, rising share prices increase those weights. Over a longer period, and using back tested data, the Equal Weighted outperformed. Since 31 December 1998, the MSCI World Net Total Return USD Index returned 559%. The MSCI Equal Weighted Index returned 679% (see charts)¹. 

Since 2020, the MSCI World Index has outperformed the MSCI World Equal Weighted Index

Since 1999, the MSCI World Equal Weighted Index has outperformed the MSCI World

Historical precedents

2026 is not the first time that markets have become highly concentrated. 

At the peak of the Japanese asset bubble in 1989, Japan accounted for more than 40% of global equity indices (today it represents about 6% of the MSCI World). Uncontrolled money supply and lending in Japan had inflated prices in property and equities. Most of the world’s ten largest companies by market capitalisation were Japanese. The largest stocks were Industrial Bank of Japan, Sumitomo Bank, Fuji Bank and Dai-Ichi Kangyo Bank, followed by US-based multinationals Exxon Corp and General Electric. The Japanese asset bubble burst in 1990, with the Nikkei stock index plummeting.

For much of the 1970s and 1980s, energy was the dominant theme. Stocks like Exxon, Mobil, Texaco, and Chevron were index giants, along with auto manufacturers such as General Motors and Ford Motor. The energy crises of the 1970s caused sharp increases in oil prices, making oil companies highly profitable.

The period 2006-2007 was characterised by a boom in the financial sector, driven by lax risk controls and unrestrained lending and repackaging of mortgages. The Great Financial Crisis of 2008 ended that bubble.

Past eras of sector dominance have often ended badly. Is it a law that over-concentration always reverts to the mean? No. But the risk is plain to see. 

MSCI World sector-index capitalisation shares

Biases in the index

The MSCI World Index currently has 1,308 constituent stocks (as at 29 May 2026). Using the iShares MSCI World ETF as a public proxy for historical MSCI World holdings, the aggregated weight of the 10 largest holdings rose from about 9% in 2014 to about 28% today ². Investors who track the MSCI World Index today are therefore allocating a large share of capital to today’s mega winners. Whether that is appropriate may depend on an investor’s objectives, risk budget and benchmark policy, but it should be a conscious decision.

Historically, top-ten membership has been a revolving door, over decades. Using the iShares MSCI World ETF as a public proxy for historical MSCI World holdings, only two of the largest 10 holdings in 2014 remain among the largest 10 today: Apple and Microsoft. The other eight are now outside the top 10. 

Just 10 securites out of 1,308 account for 27.8% of the MSCI World Index

In 2014, the largest 10 stocks in the MSCI World Index were fairly diversified as to sector: they included technology (Apple and Microsoft), energy (Exxon and Chevron), financials (Wells Fargo and JPMorgan Chase), healthcare (Johnson & Johnson), industrials (General Electric) and consumer staples (Nestlé and Procter & Gamble). Today, the largest 10 securities are all related to technology: Nvidia, Apple, Microsoft, Amazon, Alphabet A, Alphabet C, Broadcom, Meta, Tesla, and Micron. How many of these will still be in the top 10 in a decade’s time? Since the index is heavily weighted to those top holdings, poor performance from them would be a major drag on the index and would require unusually strong performance from the rest of the index to offset.

The official Information Technology sector represented 30.7% of the MSCI World Index, as at 29 May 2026, well ahead of its second biggest sector (financials, at 15.3%). Arguably the 30.7% is an underestimate of the true weighting to technology. Amazon and Tesla officially sit in Consumer Discretionary, while Alphabet and Meta sit in Communication Services, for example. 

The MSCI World Index is also heavily weighted to one country, the US, at 72.45% as at 29 May 2026. This has risen from 36.9% as at 31 January 1995 (see chart, using Bloomberg data). Again, there may be good reasons why an investor should choose to weight heavily to just one country, but there are also reasons against it. For example, the US accounts for about a quarter of the world’s nominal GDP, much less than its 72.5% weighting in the index. Again, we are not claiming here that a 72.5% weighting is right or wrong, just that there are arguments on both sides, and that to passively follow the index is therefore an active decision.

MSCI USA Index as a proportion of MSCI World Index (by market cap)

Due to its concentration in a few mega caps, in one sector, and in one country, passively tracking the MSCI World Index may not provide the breadth of diversification that some investors expect from a broad developed-market equity benchmark.

Concentration is the opposite of diversification. It may or may not be the right decision to be concentrated in technology. We may be in the midst of an AI revolution, or an AI bubble – or perhaps a complex mixture of both, where the transformative effect of AI on the real economy is real and long-lasting, but investors nonetheless get ahead of themselves at certain stages of the journey. That is a separate debate. What is clear is that to be so heavily concentrated is an active decision.

The illusion of neutrality

For investors, the practical question is not whether passive investing is good or bad. It is whether the chosen policy benchmark reflects investment beliefs, liabilities, risk appetite, governance constraints and tolerance for tracking error. A capped, equal-weighted or factor-based alternative may reduce concentration, but it may also introduce benchmark-relative active risk, higher turnover and implementation costs. The benchmark decision should therefore be documented and reviewed in the same way as any active allocation decision.

Passive investing is sometimes recommended on the basis that it is somehow ‘neutral’, or that it achieves exposure to the ‘market as a whole’, or that it avoids making what are difficult and error-prone active decisions. That is an illusion. In fact, tracking a benchmark is itself an active governance decision.

Market-cap weighting is not a passive observation of the market; on the contrary, it is a rules-based strategy that weights certain stocks, sectors and geographies above others. The rules may be fairly simple, and much simpler than the rules, heuristics and judgments used by most active funds, but they are rules nonetheless. It is an active choice to follow an index that embeds those rules.

Many well-known and important indices, including the MSCI World Index, the S&P 500 Index, and the Nasdaq-100 index are market-cap weighted indices. This means that the largest companies get the largest weights.

A key risk of a market-cap index is that it can become heavily tilted towards a fairly small number of stocks. Today, a small number of US technology giants account for a surprisingly large share of the entire index, even a giant index such as the MSCI World. If those companies do poorly in future, the index will likely do poorly too, given their heavy weight. Passive index tracking can be a sensible investment choice, but it is still a choice that should consciously accept the benchmark’s embedded stock, sector, country, and methodology exposures.

Source: Morningstar, USD, as at 31.05.2026.

Footnotes

¹ Back tested data, from Bloomberg, is used because the MSCI World Equal Weighted Index was launched on 22 January 2008. Performance before its launch date is back-tested.

² Based on iShares MSCI World ETF, as at 30 May 2014 and 29 May 2026. 

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