ETFs May Be Dragging Down Your Portfolio Returns Due to Market Concentration

A Wall Street strategist warns that popular ETFs may not be providing the diversification they promise due to market concentration. The top 10 companies in the S&P 500 are trading at record highs, and using sector-specific ETFs can lead to tracking error, limiting exposure to dominant names. This means that investors who buy ETFs may be inadvertently increasing their risk and not getting the diversification they expect.

A Wall Street strategist recently cautioned investors that popular ETFs may not be providing the diversification they promise. The top 10 companies in the S&P 500 are trading at record highs, and using sector-specific ETFs can lead to tracking error, limiting exposure to dominant names. This means that investors who buy ETFs may be inadvertently increasing their risk and not getting the diversification they expect [1].

The current market landscape is dominated by a handful of names. The Mag 7 now accounts for a historically large portion of the S&P 500’s total market capitalization. Last week, NVIDIA NVDA shares surged, briefly pushing its market cap above $4 trillion for the first time. This highlighted growing investor and market enthusiasm surrounding the AI sector. The accelerating momentum behind the AI and tech rally is powering much of the broader market’s gains. This is evident from the performance of the S&P 500 Information Technology Index, which has gained 9.44% year to date. However, investing heavily in the technology sector to capitalize on AI’s growth potential comes with increased concentration risk and systemic risk. Underlying market risks make it necessary for investors to diversify [1].

Long-term investors should consider broadening their exposure, not by abandoning the tech sector altogether but by complementing it with diversified holdings. This will enable them to preserve their growth potential while reducing vulnerability to market shocks that arise from overconcentration. What’s Making Markets Vulnerable Renewed trade tensions are casting a cloud of uncertainty over global markets. According to Yahoo Finance, President Trump unexpectedly announced on Saturday that the United States will impose 30% tariffs on imports from the EU and Mexico, effective August 1, turning investor sentiment downbeat. This further escalates global trade tensions, creating a more uncertain economic landscape and further fueling inflationary pressures. The U.S economy faces headwinds due to inflationary pressure, intensified by the tariffs proposed by the President. Concerns over U.S. debt levels, coupled with leadership and political uncertainty of the Fed, dent investor confidence. A possible Fed leadership shake-up remains a significant source of investor unease [1].

Investing in ETFs that focus on value sectors or equal-weighted strategies can enhance resilience while still capturing upside potential. Diversification remains one of the most effective strategies for building resilient portfolios, especially in a market driven by a few dominant players. Below, we highlight a few areas in which investors can increase their exposure. Investing in these sectors not only shields portfolios from downside risks and safeguards investments during market distress but also offers gains when the broader market trends improve [1].

The launch of the L&G S&P 100 Equal Weight UCITS ETF provides investors with an equally weighted exposure to the S&P 100, an index which consists of 100 major US blue chip companies across multiple industry groups. This ETF is the first in Europe to offer exposure to the S&P 100 Equal Weighted Index Net Total Return and aims to give an alternative to the standard S&P 500 Index by providing access to many of the largest index constituents, with lower concentration risk [2].

Investors should be aware that the complexity of the ETF market has increased, with more products and strategies available. This includes options-based ETFs and crypto ETFs, which can add layers of risk and complexity to portfolios. It is crucial for investors to conduct thorough due diligence and research to understand the risks and benefits of each ETF they consider [3].

In conclusion, while ETFs offer a convenient and cost-effective way to diversify portfolios, investors must be cautious of the concentration risk associated with sector-specific ETFs. By diversifying into value, equal-weighted, and consumer staple ETFs, investors can build more resilient portfolios that are less vulnerable to market shocks. Staying informed about the latest ETF developments and understanding the risks involved is essential for making informed investment decisions.

References:
[1] https://finance.yahoo.com/news/etfs-diversify-stay-ahead-225200621.html
[2] https://etfexpress.com/2025/07/17/lg-launches-lg-sp-100-equal-weight-ucits-etf/
[3] https://www.morningstar.com/news/marketwatch/20250717192/inside-the-great-etf-boom-of-2025-how-do-you-2