Welcome to my column, Young & Invested, where I discuss personal finance and investing for Gen Z and Millennials.

This column aims to be a resource for young investors navigating an ever changing financial, political and social landscape as they try to build wealth. Tune in every Thursday for the latest edition.

Edition 79

One thing I’ve learnt in my years of investing is that not everything is intuitive.

Sometimes the most convincing theories are undermined by the market itself. Things that sound reasonable in a lecture hall often don’t play out in reality.

Most investors are taught that diversification is one of the few free lunches in investing. Don’t put all your eggs in one basket and avoid becoming too dependent on any single company or sector. But this becomes more complicated when the market itself becomes concentrated.

Critics argue that this creates a vulnerability for passive investors in market-capitalisation weighted indices when the tides eventually turn. Recent evidence suggests that concentration has actually disadvantaged active investors instead.

The concentration paradox

One of the most persistent criticisms of passive investing is that it can lead to increased concentration risk. Because market-cap weighted indices allocate each dollar invested according to a company’s value, larger firms naturally take a larger share of the portfolio over time as long as the market is rising and new money is disproportionately allocated passively.

As a result, passive investors can become increasingly dependent on a small number of companies to generate returns. This concern has become particularly relevant in recent years, as global equity performance has been driven by a handful of outperformers.

Critics continue to argue that high levels of concentration leave investors vulnerable to changes in market leadership, valuations or company-specific disappointments. So, from a theoretical perspective, this should also create opportunities for active investors.

This premise relies on the assumption that active management can add value by identifying areas of the market that are overlooked or mispriced, especially as concentration increases the opportunity set. Because passive investors are mechanically allocating more money to the largest companies regardless of valuation, active managers should eventually get the advantage. However, recent data is not particularly supportive of this thesis.

Our latest Active/Passive Barometer report found that active managers in the World Large Blend category significantly underperformed their passive counterparts. Much of the performance difference has been attributed to the outperformance of mega-cap US tech firms, which many active managers remained underweight in.

This presents a challenge to the concentration argument. The very characteristic identified as a structural weakness of passive investing appears (at least in the last decade) to have reinforced its relative advantage.

Rather than creating opportunities for active managers, it has increased the difficulty of outperforming. The challenge is not simply identifying attractive investments but doing so while remaining underweight in the companies responsible for a large share of market returns.

An active manager may have legitimate concerns about valuations yet still underperform if the largest companies continue to compound earnings. Recent years have demonstrated that avoiding expensive stocks and outperforming the market are not always synonymous.

For active managers, this creates a difficult trade-off where reducing exposure to dominant companies may improve diversification and mitigate concentration risk, but it also reduces exposure to the companies that are driving returns. What appears to be sensible portfolio construction can become costly from a performance perspective.

A 2025 paper by Mark Kritzman and David Turkington titled The fallacy of concentration, sought to explore whether investors should actively attempt to offset concentration in equity markets. In their review of almost 90 years of market performance, they found that reducing exposure based on concentration offers no timing advantage and actually worsened returns and risk. They conclude that concentration has not proven to be a reliable indicator of future poor returnss.

Of course, this doesn’t invalidate the principle of diversification. It is an exercise in risk management, rather than return maximisation. The biggest risk investors ultimately face is that their investments fall short of meeting their financial goals.

That is why concentration risk is still a consideration, particularly for investors concerned with downside protection, drawdowns or portfolio resilience. Those are distinct objectives to outperformance. The right portfolio can be more diversified than the market portfolio while delivering weaker investment outcomes over the long-term. What matters is that your portfolio continues to serve your goals.

Passive investing in global equities has and is continuing to benefit from the characteristic that many critics expected would eventually undermine it. Instead, it has become one of the mechanisms through which passive funds have maintained their advantage. In this spirit, I’ll be examining one of our research team’s top passive picks in this category.

Vanguard MSCI Index International Shares ETF VGS

  • Assets under management: $17.8 billion (AUD)
  • Morningstar Medalist Rating: Gold
  • Total Cost Ratio: 0.18%
  • Benchmark: MSCI World Ex Australia

VGS tracks the MSCI World ex Australia Index, which provides exposure to ~1,200 large and mid-cap companies across 22 developed markets. The index captures approximately 85% of the investable market capitalisation across those countries and uses market-cap weighting to determine each company’s position size.

VGS is a passive ETF meaning that its purpose is to track an index. In contrast, the primary purpose of active fund managers is to research and analyse companies to outperform a certain benchmark or achieve a specific outcome like income generation.

The market cap weighting in VGS means as companies become larger and more influential, their representation in the portfolio increases. As companies decline in value, their weighting in the fund falls.

Composition

With holdings across 22 developed countries and 1,200+ companies may create the impression that an investor is receiving a relatively diversified allocation across geographies, sectors and companies. But this is not what global investing has looked like in recent years.

Despite the breadth of holdings, as of August 2026, 74% of VGS’s holdings are invested in the US, with technology representing the largest sector allocation at 32% of the portfolio. Collectively, the top 10 holdings (NVIDIA, Apple, Microsoft and Amazon) account for 27% of fund assets.

Active managers frequentlyviewthis level of concentration as a risk factor, while market-cap weighted indexes treat it as information. If market participants collectively decide a company is worth 1 trillion, rather than 500 billion, the index will reflect that judgement. Whether that reflects rationality or investor exuberance is a separate question.

Performance and costs

VGS is a tough hurdle to beat in terms of performance. Over the five years and ten years to August 2026, VGS delivered annualised returns of 11.8% and 13.7% respectively. Over these periods, the fund has remained a top quartile performer, outperforming its category by around 2%.

Holding a broad basket of companies through an index means investors do not miss out when the driver of market returns is concentrated on single sectors or positions. Our analyst notes that this has been the case over the past few years, with tech companies dominating the returns of the fund and the broader global equity market.

Perhaps the most enduring advantage VGS holds is cost. The fund charges 0.18% p.a., which places it in the cheapest quintile within its category where the median fee is around 0.85% p.a.

Additionally, our analyst notes that Vanguard conducts a variety of incremental procedures, which reduces the tracking error caused by fees. For example, they may delay trading during index rebalances to avoid unwarranted cost-inflating trades.

What we think

VGS ETF is assigned a Gold Medalist Rating, meaning we expect the fund will outperform its peers in the category. Our analyst notes that VGS offers efficient exposure to global equities at a compelling price.

The efficacy of passive management in global markets, its cost-efficient availability, and broad diversification continue to be key drivers that earn our conviction. Concerns around concentration are eased by the often diversified business structure of the largest companies, as they aren’t generally reliant on a single product, service, or market to determine success.

Concluding thoughts

The outperformance of specific markets or sectors relative to others does not imply the failure of a diversified portfolio.

In recent years, a small group of tech companies have accounted for a large share of global equity returns and thus, concentration has amplified gains for market-cap weighted indices. But nobody can accurately and consistently predict long-term equity returns.

Having a highly concentrated portfolio can also amplify losses, so it is important to understand the risks and exposures within your portfolio.

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