One of the great things about passive investing is that, even when it creates a problem, it often also provides an answer.
One such problem that has always plagued the Australian share market and has also, more recently, become a problem for the major US S&P 500 index is concentration risk.
The Australian market has always been heavily concentrated on miners and banks and this problem has recently got even worse.
Seven of the ten largest companies are now miners or banks, with those ten largest companies also representing almost half of the benchmark by value.
US Market Concentrated by Big Tech
The problems this concentration provides for passive investors is that by tracking an index such as the ASX 200, they are only getting a modest exposure to the sectors on the ASX other than materials and financials.
It has become a similar situation in the US due to the massive value growth for the booming technology sector.
The top ten US companies now represent about 42% of the total market.
That is an historic peak, so there is a danger that concentrating on a narrow range of sectors could cause underperformance.
Passive Still (Mostly) Beats Active
Of course, there is little doubt that passive investing is still the cheapest and best way to get exposure to markets—a fact confirmed by the most recent SPIVA scorecard for 2025.
An ASX 200 index fund outperformed the vast majority of active fund managers – 74% of them – and the S&P World Index also outperformed 70% of Australian active global managers.
So, if you remain logically convinced that your core exposure should be through cheap and cheerful index ETFs rather than active managers but you are concerned about the degrees of concentration in Australia and the US, is there a way to mitigate the risk?
Equal-Weight ETFs to the Rescue
Well, it turns out there is, with the arrival of equal-weight ETFs listed on the Australian market.
There is the Van Eck ASX Equal Weight ETF (ASX: MVW) for the Australian market and the Betashares S&P 500 Equal Weight ETF (ASX: QUS) for the US market, to name just two.
As the name suggests, equal-weight index funds ignore the size of the companies in the index and instead buy an equal dollar amount of each company in the index.
That does two things—it reduces sector concentration risk, and also gives extra weight to the smaller companies in the index.
Smaller companies tend to produce higher returns—so, in the case of the local Van Eck product, it has historically outperformed the ASX 200 index, although there are absolutely no guarantees that this outperformance will continue.
It is worth pointing out here that there is still some focus on size even with an equal weight ETF, given that companies will get promoted into the index or demoted out of it based on their size.
However, the equal weight option does give a more evenly spread exposure across sectors on the particular market covered by the index.
Investor Favour Comes in Waves
There are times in markets when investors crowd around the big companies, and others when smaller companies have their time in the sun, but the picking this tide is just as difficult as the task active managers have in outperforming the index.
Where the equal-weight index ETFs might fit for a passive investor is to allocate a certain percentage of their exposure to the index through the equal weight product rather than the traditional index.
That way they will still be getting exposure to the equity premium returns they want but have reduced concentration risk a little and may perhaps be compensated with some extra returns occasionally.
So, for example, if you had an over-arching 30% portfolio exposure to the Australian market, you might elect to get 90% of that exposure through the traditional ETF product such as iShares Core ASX 200 ETF (ASX: IOZ) or Betashares Australia 200 ETF (ASX: A200) and the remaining 10% through the Van Eck MVW product.
Obviously, these percentages are up to the individual investor, but sticking to portfolio percentages and rebalancing at certain intervals are also hallmarks of the traditional—but still largely hands off—passive index investor.
It is not a foolproof approach but, as most passive investors know, if you keep things simple and stick to some fairly standard portfolio rules, you can beat the vast majority of other investors, including the professionals.
Mitigating some sector concentration while remaining exposed to leading share markets is going to be hard to beat in the long run.
