Why Market Concentration Can Create Both Challenges and Opportunities for Active Investors

U.S. small-cap equities delivered remarkable returns in the second quarter of 2026. The Russell 2000 gained 21.5%, outperforming the S&P 500 by more than 500 basis points. For the first half of the year, the margin of small-cap outperformance over large caps was the widest since 2001.

Taken at face value, those numbers describe an exceptionally strong market. But beneath the surface of the index, a much more nuanced picture emerges.

U.S. equity performance during the second quarter was extraordinarily concentrated. In this type of environment, understanding what is driving an index can become just as important as the return of the index itself.

A small number of stocks can have an outsized impact

Within the Russell 2000, all ten of the largest contributors to second-quarter returns were AI-related stocks. Together, they contributed almost 500 basis points, or close to 25% of the index’s total return during the quarter.

Year to date, AI-related sectors accounted for 69% of the Russell 2000’s total return. Participation in the rally was also remarkably narrow.

While the Russell 2000 repeatedly reached new all-time highs during the quarter, only about 30% of its constituents were within 5% of their 52-week highs. By contrast, nearly 45% were more than 20% below their 52-week highs.

A strongly rising index, therefore, does not necessarily mean that most of the companies within it are experiencing the same strength.

For an active manager, that distinction matters.

The challenge of a highly concentrated market

Under more typical market conditions, stock selection is based on the premise that differences in business quality, growth, profitability and valuation will ultimately be reflected in investment returns.

When a small number of stocks or subsectors account for an unusually large share of index performance, that relationship can temporarily weaken.

That is what we observed during the second quarter. The rotation into AI infrastructure, semiconductor capital equipment, energy and high-beta small-cap cyclicals rewarded exposures that are not central to our quality, valuation and growth disciplines.

For an active manager, not owning the stocks that temporarily dominate an index can create a significant relative performance gap even when the underlying companies held in the portfolio continue to demonstrate healthy fundamentals.

Our Global Small Cap strategy experienced a similar dynamic during the quarter. Despite delivering an absolute return of 12.75%, the portfolio trailed a benchmark that gained 17.3%. Much of that relative shortfall reflected exceptional benchmark concentration: Sandisk alone represented more than a 200-basis-point relative headwind.

This is an important distinction. Relative underperformance does not necessarily imply broad deterioration among the businesses held in a portfolio.

Separating price movements from fundamental change

When momentum becomes a dominant market driver, the gap between share prices and company fundamentals can widen considerably.

Some companies benefit from extremely favourable sentiment and rapid multiple expansion. Others can be left behind despite solid operating performance.

For a fundamentally driven investor, the challenge is to determine whether a decline in a company’s share price reflects a genuine deterioration in the business or simply a change in market sentiment and leadership.

The distinction is critical. Changing an investment approach simply to follow what is currently dominating an index can mean abandoning the quality, growth or valuation criteria underlying the stock-selection process.

At the same time, remaining disciplined does not mean ignoring what is happening in the market. It means continually reassessing portfolio companies and distinguishing fundamental change from price movement.

Concentration can also create opportunity

Highly concentrated markets have another important characteristic: as capital crowds into a relatively small group of winners, high-quality companies can be left behind.

Within our U.S. strategy, we observed that a narrow, speculative and momentum-driven environment created new investment opportunities among businesses that had been ignored, overlooked or pressured for reasons we believed were disproportionate to changes in their underlying fundamentals.

The Global strategy observed a similar phenomenon. High-quality companies with durable competitive advantages, strong balance sheets and attractive long-term growth prospects were increasingly overlooked simply because they lacked an obvious market narrative.

For active managers, this dispersion can create attractive entry points.

The role of active management

Index concentration can make active management particularly challenging over short periods. When a handful of securities generate a disproportionate share of returns, a fundamentally constructed portfolio can diverge meaningfully from its benchmark.

But that same concentration can also create conditions in which fundamental research becomes especially valuable.

As valuations diverge and some businesses are left behind, the task is to identify companies whose fundamentals remain intact and whose long-term potential is not fully reflected in their share prices.

Our philosophy remains rooted in bottom-up investing: understanding businesses, their competitive advantages, balance sheets, returns on capital, management teams, long-term earnings prospects and valuations.

Markets will not always reward those characteristics in the short term. That is precisely why active investing requires discipline.

An index tells us what generated returns. It does not necessarily tell us how broadly those returns were shared, whether they reflected widespread fundamental improvement, or whether some of the most compelling opportunities may be developing elsewhere.

Sometimes, understanding the market requires looking beyond the index.