The Dangers Hidden in The Indexes: How last year’s safest investment can be the riskiest one this year

The preface to this article can be one of the most oft- repeated phrases: “past performance is no guarantee of future performance”. It is a line so frequently used that it can lose its meaning, but it is worth mulling over for a moment.

What it is saying is just because an investment did well last year, it does not mean it will do well this year. It is more than just a cursory warning though. History has shown this has often been the case. The first table below from the JP Morgan State of the Market EMEA August 2025 shows which asset classes have been the top performers globally since 2018, showing that what stars one year, may lag the next. You can assess this to say that if you build a portfolio on what did well the prior year, you will consistently underperform.

This also works within asset classes. If you consider the best share markets of the las seven years, JP Morgan’s State of the Market also addresses this. The US market was at the top in 2021, 2023 and 2024 but YTD 2025 it is at the bottom compared with other markets.

A corollary of this observation is that there is sense in tactical active portfolio management, adjusting your portfolio according to your changing needs as well as the changing world.

One sector, or style of investing that has performed well in recent years, is the collective group of passive investments, or index trackers. To an extent they are becoming a victim of their success. Applying the above principles, just because they have done well in the past, it does not mean they will continue to outperform in the future.

What is a passive or index fund?

To explain this, one first needs to define what an index is.

An index is a reflection of a market. One of the most commonly referenced indexes is the S&P 500 which is an index of the largest 500 companies listed on US stock exchanges. It is measured by market capitalisation of the listed companies (i.e. size). There are many indexes that you may see referenced in financial news and investment reports. The UK stock market is measured by FTSE indexes, the German market by the DAX, the French market by the CAC-40, and the European market by the STOXX.

An index therefore is a reflection of a market but depending on your portfolio, the returns you experience can be similar to, or very different from, the stated index returns.

Passive index investments aim to replicate an index so the returns in the passive investment match the returns of the index. It can achieve this one of two ways. One is to buy every stock in the index and hold them all proportionately. In a practical sense this is very difficult, and expensive. The second way is to buy a mix of investments will hopefully return in line with the index but which is only a representation of the index, not a full replication. You should understand how your index fund achieves its goals before you invest in one.

What is the risk?

A current risk is a reflection of the success of index funds. As more investors choose to use index funds and more funds flow in, the investment managers are required to invest in the companies that make up the index, either by full replication or by a sample. This can lead to a distortion. Because companies make up the index proportionately by market capitalization, it is the largest companies and not the best performing companies where your funds are ultimately invested.

The 10 largest companies in the index of the US stock market, make up almost 40% the total market capitalisation. For added concentration risk, nearly all are in tech or tech related sectors. This starts to look like concentration risk. If there is a downturn in tech stocks an investor that thinks they are diversifying across the whole market could see a disproportionate fall in their investments. And the investment managers are restricted by their mandate. Even if they think that this sector is overvalued, as new funds flow into the indexes, they are forced to allocate to all stocks including the ones they do not think are good value. This becomes a vicious cycle, as the successful index funds receive inflows of capital which they are forced to invest in overvalued stocks which makes these stocks even more expensive and overvalued.

At times like this, it is smart to be tactical and manage market risks. All investments go up over time but not in a straight line, which means at times they will fall in value.

There is no one singular best approach to managing your money; no absolute right or wrong and for some people at some times index funds can be appropriate, and at other times not appropriate.

Don’t switch to the automatic set and forget or follow the heard approach when it comes to managing your money. As markets are complex, and your decisions impactful on your future quality of life, get advice from a professional.

Speak with us at Black Swan Capital and make sure you are managing your money in line with your specific needs and objectives.