Insight & Outlook: Fidelity Market Signals Weekly

Investors may not own the diversification they think they do

The artificial intelligence (AI)-driven rally has pushed U.S. equity concentration to levels unseen since the 1930s. Technology now accounts for more than one third of the S&P 500. Many investors view broad index funds as diversified holdings, but today’s index composition tells a different story.

The current bull market, the strongest in a generation, was built on a powerful theme. Artificial intelligence has driven earnings, capital spending, and returns, and we remain bullish on it as a long-term structural driver. But the same forces that produced those returns have quietly reshaped what a diversified U.S. portfolio holds. A market-cap index reflects where the money has flowed—into a surprisingly small group of stocks, sectors, and, increasingly, a single theme.¹

As a result, many investors are far more concentrated than they intend to be, and the range of outcomes that concentration creates is wider than a broad-index label suggests. Against this backdrop, the Federal Reserve held its benchmark rate steady, in a range of 3.5% to 3.75% last week, and reiterated its commitment to “deliver price stability.”²

Three forms of concentration hiding in a diversified portfolio

Home bias anchors the portfolio to one market. Most U.S. investors hold a large majority of their equity in domestic markets. That is understandable, but it ties the entire portfolio to a single economy, currency, policy regime, and to whatever happens to be driving the U.S. market.

The index itself has become a concentrated position.Technology stocks now account for roughly 38% of the S&P 500,³ the 10 largest holdings exceed 40% of the index, and U.S. equity concentration sits at its highest level since the 1930s. Owning "the market" today means owning one theme to a degree that would have been difficult to imagine a decade ago.

The theme risk hides beneath the labels. Holdings that appear distinct on paper—different sectors and different tickers—can rise and fall together because they are all, in the end, expressions of the same AI trade. Diversification by label is not the same as diversification by behavior.

The key question: How many independent bets do you own?

The conversation around diversification tends to focus on the number of holdings. Historically, though, what has protected portfolios is not how many positions they hold, but how many independent sources of return those positions represent. A portfolio of hundreds of names can still be a single bet if those names all depend on the same driver.

This is where we would separate conviction from concentration. Remaining bullish on AI over a multiyear horizon does not require, or justify, carrying an unmanaged and oversized position. A theme this large and crowded re-prices sharply when sentiment shifts, as it did this spring. The risk is not that the thesis is wrong; it is that many investors are holding far more of it than they ever chose simply by owning the index.

Where the concentration sits

Concentration is easier to manage once it is seen in layers. There is a single-name risk: One company currently accounts for roughly 7% of the index.⁴ There is sector risk: The technology sector accounts for more than a third of the market. There is industry risk: Much of that weighting sits within a handful of semiconductor names. Finally, there is theme risk: a hidden risk that runs beneath companies that otherwise appear unrelated.

Addressing these risks requires being deliberate at every layer: trimming oversized positions, balancing sector exposures rather than inheriting the index’s concentrations, and adding return streams that are not driven by the same underlying theme. In the current environment, capital preservation is less about forecasting the next drawdown and more about ensuring that a single event cannot take the entire portfolio down with it.

What genuine diversification looks like

The most effective offsets are the parts of the market whose composition is fundamentally different from the U.S. index. Developed international equities sit near the top of that list. The case is not geographic for its own sake; it rests on what these markets own. Technology commands a far smaller share of the index for non-U.S. developed international markets (MSCI EAFE) than the S&P 500, while financials, industrials, and materials carry substantially more weight (Exhibit 1). That different composition is what has historically lowered a portfolio's correlations.

Emerging markets warrant a more nuanced read. We are not suggesting investors avoid developing markets, which carry real long-term merit. But their diversification value depends on intent. Emerging-market indices are also heavily weighted toward technology and platform companies, and in several cases more so than the S&P 500 (see Exhibit 1 above). A meaningful portion of emerging markets can echo the very AI and technology exposure an investor is trying to spread out. Held deliberately, emerging-market funds diversify; held by default, they can reinforce the concentration already in place.

Why this environment favors active management

Broadening a portfolio can be done with index funds,⁵ and their cost advantage is real. In our view, this is not a blanket argument against them. But the current structure of the market plays to the strengths of active management. When a benchmark is concentrated, buying the index means buying the concentration. An active approach can directly manage single-name and sector risks, size the crowded trade to conviction rather than by index weight, and invest in overlooked areas of the market.

That selectivity matters more today than it did a year ago. Market leadership is broadening, and the dispersion between winners and losers is widening—only three of the Magnificent Seven tech stocks now rank among the top 10 contributors to the index returns this year, down from all seven in 2024.⁶ A wider gap between the best- and worst-performing names is precisely the condition under which security selection can add value.
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