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This podcast series is not meant for retail investors, but instead it's meant for financial advice and investment professionals.
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Please refer to IMAP's website, imap.asn.au for more details.
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Welcome back to the IMAP Independent Thought Series Podcast.
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I'm Emily Barlow, senior asset consultant from Evidentia Private.
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And today we're looking at the SP 500, an index of the largest 500 companies in the US by market capitalization and an exposure many Australian portfolios hold, either directly or through a global index fund.
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One thing that remains top of mind for investors is concentration.
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And by the end of 2025, the top 10 stocks hit 40.7% of the index, the highest in around 60 years, which very much raises the question: is the SP 500 and the funds tracking it still giving investors the diversification they expect?
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To help us unpack all of this, I'm joined by Amit Pathak, head of US Equities and Product Management across APAC at the SP Dow Jones Indices.
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Amit, thank you so much for joining us.
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Thank you, Emily.
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Thanks for having me.
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So let's dive into what owning the SP 500 actually means in 2026.
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This is an index thought of as a fairly plain vanilla, broad market benchmark, but because it's market cap weighted, is it fair to say that it's picked up meaningful factor tilts in the last few years?
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That's a very good observation, Emily.
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And yes, um SP 500 is a market cap-based index, but due to the construction, it has meaningful exposure to growth quality and momentum characteristics.
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That is correct.
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Yes.
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And is this exposure, so this increase exposure to those growth and momentum tilts um unusual compared with the history of the index?
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So the history of the index is that it is driven by the evolution in US economy, US equity market more specifically.
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So if US equity market evolves in certain ways, so for example, technology or AI, they might become dominant theme now, may not be in the future.
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So in those cases, uh the stocks with these exposure will have higher weight.
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But 10 years or 20 years ago, Johnson Johnson and Coca-Cola were the dominant name in the top 10.
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So at that time, the index construction was very different from what it looks like now.
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And another theme, obviously, of that growth trajectory is that AI thematic, which is obviously now a fairly big theme within the SP 500.
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So I'm just interested to understand um what would happen to the index if it's deemed that AI isn't going to deliver the productivity gains that the market expects.
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And exactly how exposed is the index to that thematic?
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So that is a good question.
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And as you rightly pointed out, uh there are a lot of AI names in S ⁇ P 500 right now.
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So, for example, if you look at the top 10 constituents, Nvidia, Amazon, Meta, Alphabet, Microsoft, they're all in top 10, uh, which is pretty heavy AI uh exposure.
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And uh there are reasons why uh we have the construction or the representation of AI stock in the index is simply the evolution of the US economy.
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And if you look at the sectoral benchmark, um SP 500 has uh almost three times IT sector exposure compared to the global benchmark.
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And the reason being simple is that um these IT, these AI names have simply a huge operating profit margin compared to the rest of the world.
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So this is, as I was saying earlier, it is the evolution of US economy and how more and more the world is using AI, digital transformation, and cloud computing.
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And that basically reflected into the company's representation in the stock market.
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So that's a pretty good reminder that the index isn't static.
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And I think that leads nicely on to the topic that I mentioned in the introduction, which is that concentration and the increase level that we've seen in the last year or so, albeit um that's slightly reduced this year.
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Um is it something that investors need to worry about?
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That's a very good question.
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And in fact, concentration, yeah, we are here in Australia, and if you look at the Australian market, um ASX is um probably more concentrated.
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In fact, if you look at the top 10 names, ASX top 10 has uh roughly 10% more weight compared to SP 500 top 10.
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And in fact, if you look at other um US stock indices, uh they even have more concentrations.
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For example, Dow Jones industrial average uh is more concentrated than SP 500.
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So, yeah, concentration happens, uh, and it is the result of evolution of US economy and the regional economy, as I was mentioning about ASX.
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But um it is of course driven by how each and every sector is playing its role.
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So, for example, as I was talking about IT sector and communication sector, um SP has uh SP IT sector has 29% um operating profit
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margin compared to global, which is around 7%.
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Uh so these kind of strong margins justify how uh investors are basically positioning themselves to take exposure to these companies.
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In fact, um if you look at the global brands, so out of top 100 global brands, 49 out of them are part of SP 500.
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Uh, this again represents how um the pricing power lies with the companies which are part of SP 500.
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So all of these combinations create this unique set uh where the concentration is high.
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So it's just the evolving market dynamics.
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It's not something which an index provider deliberately try to do.
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So it's not definitely in the index construction process.
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Okay, so um the concentration, you know, you there's no way that you could construct it differently to impact that it's just a byproduct of the market and would be reflective of how any other index provider would be constructing a similar index.
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So um one can definitely construct indices which have different levels of concentration.
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So for example, SP itself has SP 500 equal weighted indices or value or quality or an equal weighted index uh which are maybe into the local markets too.
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Uh but the uh point here is if you are looking at free-float market cap-based indices, which represent the evolution in the market without any capping, then um this is the natural design of how the EU economy has evolved.
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And that's why you see the concentration.
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But of course, someone who is not looking for market beta, someone who is looking for capped exposure, reduction in uh concentration risk, they can always go for, let's say, SP 500 equal weighted index or other versions.
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Yeah.
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Yeah.
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Yeah, no, that makes sense.
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And the next uh topic I wanted to touch on is flow.
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So obviously, passive performance has been really strong uh over recent years, and we've seen significant flows increasing into passive type products.
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And that itself, you know, potentially has an impact to influence performance.
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And so I'm interested in your thoughts with that steadily growing pool of money, whether or not that does, in fact, leave a mark on price discovery.
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So that increase of flows into that pool, into that passive type of investing.
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That's a very relevant question.
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And you are totally right that passive has become a significant force.
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So in US market, more than 50% of assets are in passive now.
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And uh we hear questions all the time from investors or market participants that whether it is resulting in, let's say, distortion of market or price discovery process.
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Now, there is uh no quantitative data which can justify uh saying that passive flows or increased of increased participation of passive flows in the market is distorting price discovery.
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So for example, uh let's say you want to buy Apple and Apple has 7% rate in S P 500.
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If you are investing via a passive fund, you will own Apple at exactly 7% rate at exactly the price where the index is trading or the market security is trading right now.
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So you have no uh way to affect the price or market price discovery of that particular stock.
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So it is it is actually the case that the marginal buyer from the active side, active investors, they are the one who decide uh or do the price discovery.
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So again, for example, if an active player believes that a stock, say A, should be trading at 105 and not 100, then they are the one who are deciding when or at what level they should buy.
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And hence they are affecting the price discovery process.
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So it is quite clear statistically, uh, as well as from the evidence, that passive flows are not resulting in market distortion or resulting in price discovery.
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So that's an interesting one in um bringing it back to the Australian market, which has been also driving uh towards passive, but in some cases for different reasons.
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So we've had the your future, your super performance test, which has very much pushed super funds towards passive.
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And they are such big asset owners across this market.
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Many argue that that is why bank valuations have got as high as they have.
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Now, is that just uh a component of Australian market, or is that not actually contributing to the performance of those banks, do you think?
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Yeah, so again, going back to the same point, um, the data does not suggest that passive flows uh increase the valuation or result in price discovery or any kind of distortion in the market.
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So um there might be some fundamental reasoning behind um why valuation of banks has gone so much up in in Australia.
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There might be genuine reasons why investors believe that um banks should be traded at this particular multiple.
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But definitely it's not the passive flow which is resulting in the premium or discount of any particular sector or security.
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Okay, let's take a different angle and talk about um what you're not getting exposure to by investing in an index fund.
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With so many of today's fastest growing companies staying private for longer, is the public market becoming a less complete picture of the US economy?
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That's a very good observation.
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Um it may be true that more and more companies are staying private.
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Um, and it means that maybe some of the innovation and economic activity sit outside the public market today.
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But still, the public market remains a very powerful reflection of US corporate landscape, representing many of the largest, most influential, and most investable companies.
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So the companies that we talked about earlier, right?
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So from an index perspective, uh SP 500 is designed to measure the public traded, publicly traded market and not the entire economy.
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And as I was saying, it is still a very significant part of the economy.
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So the strength of the rule-based index, which SP 500 is, is that as market evolves, so for example, new IPU happens or new companies get listed, they become part of the benchmark.
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And uh investors uh have a chance to access that part of the market.
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So I mean, I would frame this thing not rather the public versus private.
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Um, it is really an expanding ecosystem where the public market continues to offer investors transparent, liquid, and broad exposure to the US corporate growth.
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So I think one interesting case study to touch on um that happened only a few months ago was SpaceX and that IPO very public and well-covered listing.
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And different index providers took different approaches to the inclusion of that company within their indices.
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Could you talk us through what SP's decision was regarding that and why it came to that decision?
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Sure.
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So different index providers they have um different rules and objectives when they construct indices.
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Um, I mean, the demand for investors for these kinds of um stocks are understandable, but index providers they often consider transparency, valuation, liquidity, and replicability.
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So, for example, S ⁇ P Dow Jones indices, we believe that index innovation should be guided by clear, rules-based methodology and not by individual companies.
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The opportunity is to access the broader market, at the same time to maintain the integrity of the index.
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So the key is, of course, balancing between innovation,
transparency, and objectivity.
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Um and uh at the same time, I must say that uh SP also offers private market indices.
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It also offers other indices which have SpaceX as one of the components or constituent, but SP 500 currently it does not have a SpaceX as one of the constituents.
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Hopefully it's clear, yeah.
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So if we take some time to perhaps look forward, what do you see the next wave of market leadership coming from?
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Yeah.
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So it is uh anybody's guess.
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Nobody has a crystal ball to predict where the next wave of innovation or growth or leadership will come from.
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Um but uh the advantage of investing or going via a rule-based index is that it does not need to forecast winners, right?
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So as leadership evolves, indices evolve with the market.
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We just discussed about um companies, private companies going into the public.
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So those kinds of innovation and evolution get automatically captured into an index which is rule-based.
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So for many investors, um, it is usually not about timing the market, but it is about uh trying to go for diversification and investing in a rule-based methodology, which ensures that as the time evolves, um, the market structure is captured through this evolution.
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Yeah.
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And finally, what is it that professional index providers are watching closely right now that perhaps other everyday investors aren't paying attention to?
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Yeah.
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So everyday investors, as you can guess, they focus on performance.
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But index providers like us, we focus on methodology and market structure.
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So we closely monitor liquidity, investability, and changes in the eligible investment universe.
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So we track corporate actions, market development to keep benchmark accurate and representative.
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Um, the most important part, of course, for us is index governance, which is very critical.
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Uh, our methodologies are regularly reviewed to ensure that they continue to meet the stated objective.
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As I was saying earlier, our role is not to predict winners, but to maintain transparent, rules-based benchmark that investors can trust.
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Amit, thank you so much.
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This has been a great reminder that an index fund sitting at the core of so many client portfolios is far from static.
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And concentration, methodology, and governance are all important considerations when thinking about those passive allocations within a diversified portfolio.
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Thank you, Emily.
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It was nice talking to you.
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And thank you to everyone listening.
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If you enjoyed today's episode, please do share it with your colleagues at Network, and we look forward to having you join us next time.