What your index fund quietly became while you were not looking

I am not about to argue against index funds. I own several and I expect to die owning them. But “the index” is not a fixed object, and a portfolio built on the assumption that it is will drift somewhere you did not choose.

Concentration is a decision you did not make

A capitalisation-weighted index concentrates automatically when a small number of constituents outperform. That is the design working as intended. It also means the top-ten weight in a broad domestic index has roughly doubled over a decade without a single investor deciding to double it.

The effective-holdings column is the inverse of the sum of squared weights, which is a rough way of asking: if this fund were equal-weighted, how many names would give the same concentration? Forty-nine, in a fund that holds several hundred.

Sector drift follows

Because concentration is not random across sectors, a broad index fund now carries a sector tilt that a person constructing a portfolio from scratch would probably not choose. There is nothing wrong with the tilt. The problem is only that most people holding it do not know they hold it, and describe their allocation as neutral.

Neutral to the market is not the same as neutral. It is a specific bet that happens to be the average one.

The one thing worth doing

Once a year, look up the top-ten weight of every fund you own and add it to a single sheet with the dates. That is fifteen minutes of work and it turns a slow structural change into something you can see. I have four years of that sheet now and it has changed two decisions, both of them about position size rather than about whether to hold the fund.