Sebastian Lancetti
- Market concentration is surging – Top 10 stocks now make up over 25% of major indices, amplifying risk in passive equity portfolios.
- Target Diversification gives control – Investors can now dial in their preferred diversification level without high costs or heavy turnover.
- Smarter than traditional tools – This framework avoids the pitfalls of capping and equal weighting while preserving market exposure.
Is your equity portfolio dominated by a few mega-cap stocks? You’re not alone. With markets more concentrated than ever, many investors are left asking: am I as diversified as I should be?
Introducing FTSE Russell’s Target Diversification framework – a next-generation innovation that lets you fine-tune the diversification in your portfolio without giving up market exposure. It’s like turning up the “diversification dial” with precision control.
Why diversification matters
Diversification is a foundational principle of investing. It’s about spreading your investments across a variety of stocks or sectors, so your portfolio isn’t overly reliant on the performance of just a few big names. When done right, diversification reduces risk and helps create a smoother ride through market ups and downs.
But here’s the problem: most traditional index funds use capitalisation-weighted indices as their performance targets. These are currently heavily weighted toward the largest companies and countries. That means a handful of stocks (and markets) have an outsized influence on your returns – and your risk.
For example, take the FTSE Developed index, which includes stocks from 25 developed stock markets. Since 2007, the aggregate weight of the top 10 holdings in the index has increased dramatically, expanding from 9% and recently hitting 26%. Over the same period, the US country weight increased by 25.3 percentage points to 70.8%, while the technology industry weight nearly quadrupled.
Aggregate weight of the largest 10 constituents in the FTSE Developed index
Historically, investors have had limited options to address the concentration problem. You could switch to an equal-weight index (where every company has the same weight), but that often leads to high turnover, higher costs and performance that strays far from the market. Or you could use a capped index, where the biggest weights are limited – but that’s a blunt instrument with drawbacks of its own.
A smarter, smoother way to diversify
The FTSE Russell Target Diversification framework changes the game. It’s a breakthrough approach to index design that offers you:
- Customisable diversification – You choose the level of diversification you want.
- Low tracking error – stay closely aligned to the overall market.
- Low turnover – keep trading costs and tax impacts in check.
- No arbitrary caps or heavy optimisations – just smart, smooth adjustments.
How does it work? At its core is something called the FTSE Russell Diversification Factor – a simple, intuitive metric that tells you how diversified your index really is. Think of it like this: if your index has a Diversification Factor of 200, that’s equivalent to holding 200 equally weighted stocks. The higher the number, the more diversified you are.
Then comes the clever part – the Target Diversification Algorithm. This adjusts the weights of stocks in the index to hit your desired diversification level. It’s a full-portfolio approach, not just a cap on the biggest names. The result is a smoother distribution of weights that avoids the pitfalls of traditional methods, all while preserving the index’s market-like qualities.
A worked example – the FTSE Developed Target Diversification Factor 400 index
Let’s take the FTSE Developed index as an example and set the Diversification Factor as 400.
A simulation of the FTSE Developed Target Diversification Factor 400 index would have delivered compelling performance characteristics compared to both cap-weighted and equal weighted alternatives.
Simulated past performance: FTSE Developed Target Diversification Factor 400 index
Compared with the capitalisation-weighted parent index (see the table), the Target Diversification index would have offered similar returns (7.26% vs 7.43%) with slightly lower volatility (16.82% vs. 17.13%).
Importantly, it would have achieved a considerable improvement in diversification (30% more diversified, on average) while maintaining minimal tracking error to the parent index (just 1.40% annually) and a beta of nearly 1. This would have made the index an interesting proposition for investors with benchmark-aware mandates seeking a more diversified equity allocation.
By comparison, an equal-weighted approach would have resulted in lower performance, a much higher tracking error and a beta of only 0.84.
Comparative performance and risk statistics for the FTSE Developed Target Diversification Factor 400 index
| Target Diversification 400 | Equal Weighted | FTSE Developed index | |
|---|---|---|---|
| Cumulative Return | 236.78% | 185.44% | 246.15% |
| Annualized Return | 7.26% | 6.24% | 7.43% |
| Annualized Volatility | 16.82% | 15.83% | 17.13% |
| Risk Adj Return | 0.43 | 0.39 | 0.43 |
| Sortino Ratio | 0.59 | 0.54 | 0.60 |
| Max Drawdown | -54.98% | -55.025% | -55.06% |
| Tracking Error | 1.40% | 7.21% | |
| Information Ratio | -0.12 | -0.16 | |
| Annualized Alpha | -0.03% | 0.07% | |
| Beta | 0.98 | 0.84 |
Source: FTSE Russell. End of 2007 to April 2025. The data includes back-tested, hypothetical performance. Please see the end for important legal disclosures.
Why now?
Market concentration is reaching historic highs. Above, we showed the rise in concentration of the FTSE Developed index during the last two decades. In the US, a handful of tech giants now make up a massive chunk of major indices like the Russell 1000. That means your so-called diversified fund might be a lot riskier than you think.
With FTSE Russell’s Target Diversification, you can take control – reweight your exposure, reduce reliance on a few companies and manage concentration risk proactively. And you don’t need complex models or opaque strategies to do it.
Old tools vs. new thinking
Traditional capping methods put a hard limit (say 5% or 10%) on how big any one stock can be in the index. That sounds helpful, but it’s reactive and only kicks in when a company gets too big. It can also cause trading frictions and distortions.
Equal weighting gives each stock the same size in your portfolio, which boosts diversification but often strays far from the market and leads to high turnover and exposure to illiquid stocks.
Target Diversification avoids these extremes. It gives you the best of both worlds – a thoughtfully diversified portfolio that diverges less from the market, with fewer costs and surprises along the way.
The future of diversified investing
FTSE Russell’s Target Diversification framework isn’t just an upgrade – it’s a reimagining of how investors can manage risk in a concentrated world. It brings a level of control, transparency and precision that was previously out of reach for many investors.
Whether you’re building a core portfolio or looking to reduce concentration risk, this is a powerful new tool designed for the needs of today’s markets – and tomorrows.
Diversification just got smarter. And it’s about time.
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