Use Active ETFs to Avoid Concentration Risk

Megacap tech’s leadership role in the markets has done much of the heavy lifting for markets this year. Concentration risk in the S&P 500 has risen higher than it was at the start of the dot com bubble in 2000. The five largest stocks tracked in the S&P 500 make up almost one-fourth of the S&P 500’s market cap. That should concern cautious investors and invite a closer look at how active ETFs may be better positioned to avoid concentration risk than their passive counterparts.

See more: “Choose Diverse Active ETFs Over Narrow Thematic Funds“

Many passive strategies rely on market-cap-weighted indexes that, of course, prioritize some of the biggest names. That sometimes creates indexes that are quite top-heavy – like the S&P 500 right now. Even with the S&P 500 up 20% YTD, investors and advisors should approach it with caution. Should those mega-cap tech names like Microsoft (MSFT) dip, the S&P 500 overall could struggle. Given the lagging impact of rising rates on tech, in particular, that could be a risk.

Avoiding Concentration Risk

That’s where active funds come in. Active managers don’t have to strictly follow an index and the rules therein. So whereas a market-cap-weighted index almost needs to overweight those big, top-heavy names to produce returns, active ETFs adapt. They can get in for an upswing, but with more caution, and get out quickly as needed. What’s more, many active strats include various options or dividends to help if a big swing goes south, for example. Total return dividends can also help lift a successful strategy.

While some may look at active strategies and think only of narrow thematic strategies, passive ETFs include some of the biggest narrow thematic strategies available. Active ETFs that don’t come with an outright thematic remit have more freedom, and as such can avoid much of the concentration risk that passives face.

T. Rowe Price offers a suite of active investing offerings. The firm’s active strategies include the T. Rowe Price Blue Chip Growth ETF (TCHP) and the T. Rowe Price Growth Stock ETF (TGRW), among others.