The concentration risk lurking in your index fund

For South African investors, the past few years have reinforced an important truth: diversification is not simply about owning “the market”. It is about understanding what is actually inside the index – and where the risk and return are really coming from.

This matters whether investors are allocating locally through the JSE all share index or offshore through large global benchmarks such as the S&P 500. At first glance, these indices appear broad and diversified. The JSE all share index represents the wider South African listed equity market, while the S&P 500 includes 500 of the largest companies in the US. But beneath the surface, both indices can be far more concentrated than many investors realise.

At Laurium Capital, we believe this concentration risk is one of the most important portfolio construction issues facing investors today. It does not mean investors should avoid index exposure altogether. Rather, it means they need to understand the underlying exposures they are taking on – and ensure that their portfolios are not unintentionally dependent on a narrow group of shares, sectors or themes.

Concentration risk is real – locally and offshore

The South African equity market has long had a concentration challenge. The JSE all share index is broad in name, but a relatively small number of large companies can dominate index returns and investor outcomes. Today, the largest JSE-listed companies by market capitalisation include globally exposed businesses such as Richemont, Glencore, AngloGold Ashanti, Naspers, Gold Fields, FirstRand, Capitec, Standard Bank, MTN and Valterra Platinum. In other words, a significant portion of the local index is driven by a narrow group of rand-hedge, resources, financial and platform-type companies.

This creates two important risks for South African investors.

First, the local index may not always reflect the domestic economy in the way investors expect. A strong year for gold shares, global luxury goods, Chinese technology exposure or diversified miners can drive index-level performance, even if many South African-facing shares are under pressure. Conversely, weakness in a few large counters can drag the index lower, even where opportunities exist elsewhere in the market.

Second, passive exposure to the JSE all share index can leave investors more concentrated than they realise. A portfolio may look diversified because it owns many shares, but the outcome may still be heavily influenced by a small number of companies.

This is not unique to South Africa. The same issue has become increasingly visible in the US, where the so-called Magnificent Seven – Apple, Microsoft, Nvidia, Alphabet, Amazon, Meta and Tesla – have dominated the S&P 500 in recent years. By early June 2026, these seven companies accounted for roughly a third of the S&P 500’s total value, meaning that a passive investor in the index had a significant allocation to a small group of mega-cap technology and technology-adjacent businesses.

The headline return can hide the real story

Market concentration becomes especially important when investors look at index returns. The S&P 500 has delivered strong returns over recent years, but a meaningful portion of that performance has been driven by a narrow group of mega-cap shares.

In 2023 and 2024, the Magnificent Seven contributed more than half of the S&P 500’s total gains. In 2025, the picture began to broaden, but the same group still had an outsized influence on the index. In 2025 the Magnificent Seven returned about 23% versus approximately 16% for the S&P 500, contributing close to half of the index’s gains.

This matters for valuation too. Investors often look at the S&P 500 and conclude that the US market is expensive. In aggregate, that may be true. But the aggregate valuation can be distorted by the largest, fastest-growing and most highly rated companies in the index. If those shares are removed, the remaining “S&P 493” can look less expensive, less extreme, and in some cases more attractive than the headline index suggests.

The same logic applies locally. A market index can appear expensive, cheap, strong or weak depending on what is happening in a handful of large shares. Investors therefore need to look through the index and ask: what is driving the return, what is driving the valuation, and how much of my portfolio outcome depends on a small number of names?

Concentration is not automatically bad

It is important to be clear: concentration is not always a problem. Some companies become large because they are exceptional businesses that have compounded earnings and cash flows over long periods. Many of the world’s largest companies have strong balance sheets, dominant competitive positions and exposure to powerful structural themes such as AI, cloud computing, digital advertising, semiconductors and global platforms.

The issue is not that investors own these companies. The issue is whether they own them knowingly, at the right price and in the right size.

This is where active management and careful portfolio construction can play an important role. The goal is not simply to avoid the largest companies. It is to assess whether the risk/reward remains attractive, whether earnings expectations are realistic, and whether there are better opportunities outside the index heavyweights.

Mega-IPOs could change index composition and liquidity

The next phase of concentration risk may come from the private market pipeline. Large private companies are staying private for longer, growing to enormous scale before listing. When they eventually come to market, they can immediately become systemically important to index composition and market liquidity.

SpaceX’s IPO provides a useful real-time example. The company listed on the Nasdaq on June 12 under the ticker SPCX, after pricing 555.6-million shares at $135 each and raising $75bn – the largest IPO on record. The shares opened at $150 and closed at about $161 on their first day of trading, a gain of roughly 19%, lifting SpaceX’s market capitalisation to about $2.1-trillion. At that size, SpaceX is not simply another new listing; it is one of the largest companies in the market from day one.

For investors, the implications are significant.

First, a mega-IPO of this scale creates a liquidity event. The capital required to buy the new shares must come from somewhere. Some investors may use new inflows or cash, but others may need to sell existing holdings to fund the allocation. This can create short-term pressure in other parts of the market, particularly in liquid mega-cap stocks that are easiest to sell.

Second, index inclusion rules matter. If a newly listed mega-cap company enters major indices quickly, passive funds and benchmark-aware investors may be forced to buy it regardless of valuation. This can create technical demand that is driven less by fundamentals and more by index mechanics. For investors who own index funds, exposure to the new company may arrive automatically.

Third, large IPOs can reshape market composition. If companies such as SpaceX, OpenAI or Anthropic eventually enter public markets at very large valuations, the already concentrated nature of global indices could become even more pronounced. The centre of gravity in indices may shift further towards technology, AI, space infrastructure, digital platforms and other high-growth themes.

Fourth, public market investors may be buying after much of the early value creation has already taken place. When companies stay private for longer, venture capital and private investors may capture a substantial portion of the growth before the IPO. Public investors then need to be particularly disciplined about valuation, liquidity, governance and the sustainability of future earnings growth.

What this means for South African investors

For South African investors, the key lesson is that index investing is not risk-free and it is not always as diversified as it appears. This is especially important for investors who are building portfolios across local and offshore markets.

The opportunity beyond the obvious

Concentration risk also creates opportunity.

When capital crowds into a narrow group of shares, other parts of the market can become neglected. This can create attractive opportunities for investors willing to look beyond the index heavyweights and focus on fundamentals, valuation, earnings quality and long-term return potential.

In a market where the index is increasingly shaped by a small number of powerful companies, investors need more than exposure. They need insight, discipline and active management.

Kim Zietsman is head of SA business development and marketing at Laurium Capital.

For information on Laurium’s fund offering, please contact ir@lauriumcapital.com or visit www.lauriumcapital.com.

Laurium Capital is an authorised financial services provider (FSP 34142).

This article is published for information purposes and does not constitute financial advice. Past performance is not necessarily a guide to future performance. Investors should consider their individual circumstances and seek appropriate professional advice.