Concentration Nation: The Risks Behind Peak Passive

Tony Svach: I'm Tony Svach, head of U.S. Intermediary Distribution here at Allspring Global Investments, and welcome to SpringTalk. Today, I'm joined by John Campbell, head of Systematic Core, to tackle a fascinating angle at the market's concentration problem—what we're calling peak passive. So, as passive investing dominates flows and market influence, we're seeing new challenges emerge from reduced price discovery to other potential inefficiencies. And John's here to share his insights on what this means for investors and how systematic strategies can help navigate this shifting landscape. Welcome, John.

John Campbell: Hi, thanks for having me.

Tony Svach: So, what does peak passive mean? I hear a ton of media and different sources talking about the Mag 7 concentration in that issue. But how is this similar or different to that related concentration from the problem that we're seeing in the markets?

John: Yeah, so I think of the Mag 7 concentration, or concentration in general, as a symptom of peak passive. And what I mean by that is, over the last few decades, we've seen a significant increase in index investing over active management. And as a result, all of those increasing flows, we have seen an increase in concentration to the largest names in the index. I think peak passive is a phrase that we're discussing, which it may be time where we start to see a change in some of those flows, primarily because of some of the risks that have arisen as a result of the overreliance on passive investing.

Tony: And then, would you see other indicators, too, where—for example, boomers go from accumulation to decumulation—that could have a factor on flows, which could kind of accelerate this issue in the future?

John: Definitely. Just looking at flows over the last few years, we've seen hundreds of billions of dollars per year coming out of active management and into index funds or passive management. And that may continue. However, as our society ages, and the boomers who have accumulated a lot of wealth and have devoted a lot of assets to index funds, and once they start getting into a spending phase, then those flows could change and that could have a dramatic impact on the markets.

Tony: So, how would these risks materialize? What would it look like as you see this pendulum swing in a different direction?

John: Because the index has gotten so concentrated and the concentration is all around a handful of companies that are kind of in a similar line of business and technology—and the markets have become so reliant on this handful of companies—if we get into an outflow mode, then those stocks get sold simply because people need their money and the markets are heavily concentrated. And that puts a major downward force on the market.

Tony: Yeah. And we've had a lot of conversations around Mag 7 concentration and some challenges there. Your team has navigated this really effectively in your strategies by working through that concentration challenge. Tell me a little bit about how you've gone about doing that over the past few years.

John: So, our team, the Systematic Core team, we use a quantitative approach to investing in addition to a fundamental lens. And being quantitative investors, we have an alpha model that allows us to evaluate a broad array of stocks—the entire universe of investable stocks. And so, while we have an opinion on the Mag 7, we also have opinions and rankings on all of these other stocks. And so, we have the ability to look outside of the Mag 7 for other attractive investment opportunities. And additionally, we also put a high importance on risk management. And so, we want to participate where we can in the major themes, but we don't want to get caught offsides in relation to certain factor exposures or certain thematic exposures. So, it's really important to manage not only your size exposure but also other factor exposures that might come along with this concentration in the market.

Tony: As we hit this peak passive challenge we've got in front of us, what areas of the market should investors focus on for opportunities going forward here?

John: This is a really important time for investors to start to diversify. Some investors may not even realize how much reliance they have on these mega-cap stocks. They may own multiple index funds and not realize that the same stocks are in their S&P 500 fund, as are in their large cap growth fund. So, it's important for investors to diversify. There are great opportunities down cap in the U.S. There are great opportunities in international stocks. Many people would probably be surprised to hear that international stocks outperformed U.S. stocks last year.

Tony: Right.

John: And it wasn't necessarily because they had better earnings. They had good earnings at more reasonable valuations and so, investors started to rotate. We also have seen a rotation just in the last few months into smaller-cap stocks. Year to date, the S&P 500 is basically flat while small- and mid-cap stocks are up about 5%. So, we are seeing this rotation and it's healthy for the market, but it's also time for investors to look at diversifying into other opportunities.

Tony: That makes sense. Before you mentioned some of the concentration in technology. I think we have to say AI (artificial intelligence) in any podcast. I think that's like a rule now pretty much across the board. So, from an AI perspective, this exuberance that we have in the AI marketplace and then this peak passive dynamic going on, are these things correlated? How do you see these things tying together? And how do you think about that as an investor?

John: This is an important issue because we've had periods of high concentration in the markets in the past, although this is the most extreme example. I mean, as of the end of 2025, the Mag 7—the top seven stocks—make up about 35% of the S&P 500. And so, we've seen other periods of concentration where maybe the largest stocks were 15% or 20%. But in those instances, those larger stocks were a more diversified group of stocks. When you look at the end of the dot-com bubble, only two of the top seven stocks were actually technology stocks—Cisco and Microsoft. Other stocks were also names like GE and Walmart and Pfizer. And so, it's not just the concentration that's the problem. It's the concentration in stocks that are all alike. And in this case, they're all exposed to the AI theme. So, if something happens to lose investors’ confidence in the AI theme or the return on investment doesn't come or it doesn't come as fast as investors hope, then we've got a really concentrated bet on a small group of stocks that are all experiencing the same kind of business dynamics.

Tony: And we've talked before. Your team balances both systematic and fundamental investing together. As they look at—you know, there are more than seven stocks out there—so as they look at the wider universe, what opportunities do they see AI providing in the broader universe of stocks that you have to choose from for your team?

John: Yeah. This is an important issue. So, AI has been a dominant theme for the last few years. But for the most part, the companies and the stocks that have done the best are what we would call AI enablers or kind of like the picks and shovels of the AI build-out—so, the NVIDIAs and the companies that are building the infrastructure for AI. Now, we're starting to see a bit of a rotation into companies that are going to be the AI beneficiaries, so to speak, or companies who are going to be able to take AI and make their businesses more efficient and streamlined and hopefully more profitable. So, hopefully the AI theme is broadening out. On the flip side, we're also seeing a lot of volatility in the market over AI disruption. And so, people are now worried, oh, someone's going to build an AI agent that's going to disrupt my whole business. And that may be overblown, but it's a risk that needs to be managed. So, in our process, we're focused on company fundamentals and we're doing that through a quantitative lens. But we're also very focused on risk management. So, we want to make sure that we understand our thematic exposures. What do our portfolios look like in terms of our exposure to AI enablement or AI disruption? So, you've got to look at it from both directions. Alpha opportunities. So, where is AI driving good company fundamentals, but also, what risks are being posed by AI?

Tony: So, I'm a big fan of factors and we've had this conversation a couple times before. As you talk about managing risk, how do you leverage the systematic component of your investment process? How do you use those factors to manage risk in your portfolios?

John: Yeah, it's a great question. So, we are factor investors and we're using factors both from an alpha and a risk perspective. So, we identify factors that we believe and have shown to be able to discriminate winners from losers in the stock market. And so, the primary factors that we're looking to generate alpha are value-type factors, earnings quality, or management behavior factors in addition to momentum, whether it's fundamental momentum or price momentum. And so, we want to make sure we don't have an overreliance on one factor like momentum. But then, we also take this multi-dimensional risk approach. And so, we don't want to be exposed to factors that are not aligned with our alpha model. And so, we're very careful to manage and monitor our risk exposures to other factors that we don't have an explicit forecast on.

Tony: That makes sense. So, we'll wrap up with this question here. So, there's been a lot going on from an AI perspective and technology perspective. And so, having done this for a number of years and having a systematic and fundamental approach to your investment process, what are some of the most exciting resources or tools that your team has gotten access to to enhance your process in investing on behalf of clients?

John: Yeah. I'll highlight two areas that have been really exciting over the last few years that have enhanced our process. One is the utilization of machine learning. So, we have a process where we utilize machine learning to help us sort of maximize the effectiveness of which factors that we choose. So, that's been an excellent addition to our alpha model. We also have been using natural language processing to help us identify these themes like we've been talking about. And so, we can scour news or financial transcripts or filings to help us better identify which themes companies are exposed to. And we actually have a white paper coming out on this very soon, which illustrates how we've been thinking about this and using natural language processing to manage our exposure to these themes.

Tony: A lot of exciting tools and resources available to your teams. As we go forward, I'm sure there'll be many more over the next couple of years. Well, thank you, John, for being with us today and sharing your insights. And for our audience, thank you for joining us on this edition of SpringTalk.