Market Concentration in the UK Equity Market

Understanding market concentration helps advisors guide clients in balancing risk and diversification, ensuring portfolios are aligned with long-term goals while minimizing unnecessary exposure to concentrated risks. While it might seem like a recent trend, market concentration has long been a key feature of the United Kingdom's equity landscape.  

For a deeper analysis of market concentration in the UK, complete with data visualizations from Morningstar Direct, download the full research report. 

Market concentration refers to the degree to which a small number of firms or stocks dominate a market. This dominance is often measured by the share of total market capitalization held by the largest companies. In highly concentrated markets, a few large firms drive most of the market's returns and movements, while smaller companies play a more limited role. 

Many global markets have seen a trend toward narrower leadership in recent years, with larger stocks leading performance.  

This is evident in the United States, where the "Magnificent Seven" mega-cap stocks or companies like Apple, Microsoft, and Alphabet—have been responsible for much of the market's gains. However, this pattern is not limited to the US. Similar trends are also visible in other global markets, including the United Kingdom. 

Historically, the UK has been one of the most concentrated equity markets globally. However, thanks to an environment that has largely favored growth stocks, recent concentration levels for the value-oriented UK market are lower than the peak seen in 2009, when a few companies held an even larger share of the market. 

One challenge for UK equity managers during periods of high concentration is outperforming passive indexes.  Active managers who don’t have substantial weight in these top stocks find it difficult to keep up, given that less than a third of stocks outside the top 10 in the Morningstar UK Target Market Exposure index managed to outperform the benchmark during the recent period of rising concentration from January 2022 to August 2024. 

The focus often shifts from broad stock selection to positioning in just a few stocks. This presents a major challenge for those whose investment strategies involve diversification across a wider range of companies. 

In concentrated markets, where a few large firms dominate performance, advisors can capitalize on the potential for outsized returns. This has played out in growth-driven markets like the US, where the largest stocks have seen substantial gains since 2009. For clients with a higher risk tolerance or those seeking growth, leaning into momentum strategies or selectively tilting portfolios toward these large-cap leaders could yield substantial results. 

For passive investment strategies, market concentration can be beneficial as well. Advisors with clients in index-tracking funds may find that these strategies typically mirror the composition of major indices. When market concentration is high, simply tracking the index can deliver strong performance without needing active management. 

When market leadership is concentrated in a few large firms, any changes in the performance of these top companies can lead to significant market movements. This volatility can translate into rapid shifts in a client's portfolio, particularly if they are heavily invested in the largest stocks.  

Smaller companies and new entrants often struggle to gain traction in a market dominated by a few large players. The concentrated nature of the market can thus reduce the potential for growth beyond the established giants. For clients looking to broaden their exposure beyond the top firms, advisors may need to identify niche or smaller-cap strategies that offer potential growth outside the largest stocks. 

Periods of high market concentration tend to benefit funds that ride market momentum. During such times, funds that increase exposure to the top-performing stocks often outperform those with more diversified portfolios. This was evident in the period leading up to the 2008 financial crisis, where managers with concentrated portfolios enjoyed superior returns. However, when the crisis hit, those who had maintained more diversified strategies fared better, as the collapse of a few large companies sent the market into turmoil. 

Given the complexities of navigating market concentration, investors may benefit from a balanced approach that blends the potential rewards of concentrated market exposure with the stability of diversification. While concentrated funds can offer the opportunity for high-momentum returns, a diversified portfolio can help manage the risks associated with sudden market shifts. 

Advisors should assess: 

If fund managers can adapt to the changing market conditions. Are they focusing too heavily on the most prominent companies or seeking to balance momentum with diversification? A fund's strategy should align with the investor's long-term goals and risk tolerance. 

An advisor using Morningstar Advisor Workstation can assess their focus on prominent companies and diversification by looking at various data points, including: 

• Number of Holdings 

• Weighting of Top Holdings 

• Sector Exposure 

• Market Cap Exposure 

• Correlation with Benchmarks 

• Beta 

• Risk Analysis 

• Standard Deviation 

• Sharpe Ratio  

Advisors can determine whether they are overly concentrated or diversified by analyzing these data points among other portfolio metrics. 

Keeping track of market trends and the performance of key companies. This will allow advisors to adjust their strategies as market dynamics evolve. Staying informed can help identify when concentration will likely peak or when a shift toward broader market leadership may occur.  

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Concentrated markets offer the potential for significant returns, but they also carry the risk of volatility and underperformance, particularly for active managers who struggle to keep pace with index-driven performance. By adopting a well-balanced investment strategy, investors can capitalize on the strengths of concentrated markets while managing their exposure to potential risks.  

Ultimately, the key to long-term success in a concentrated market lies in staying informed, being adaptable, and maintaining a diversified portfolio.