Generate market-like returns and managed concentration risk in one structure

Passive investing has become a cornerstone strategy for many investors seeking broad market exposure with low fees and minimal complexity. But as indices become increasingly concentrated - dominated by a handful of large companies - passive investors face a new challenge: how to track the market without being overly exposed to its biggest names.

In previous sections of this mini-series on separately managed accounts (SMAs), I discussed how SMAs work, how to build a growth portfolio in an SMA structure and generating regular income through the SMA structure. In this third piece, I’ll explore how you can use an SMA structure to achieve market-like returns while actively managing concentration risks – particularly in sectors like Australian banking and global technology.

The key is blending traditional index exposures with smart beta strategies and low-cost active managers.

The problem with passive: index concentration

While passive investing is designed to mirror the market, it also inherits the market’s imbalances. In Australia, for example, Commonwealth Bank (ASX: CBA) holds a weight of over 10% in the ASX 200 index. Globally, the “Magnificent Seven” tech stocks—Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT), Alphabet (NASDAQ: GOOGL), Amazon (NASDAQ: AMZN), Meta (NASDAQ: META), Nvidia (NASDAQ: NVDA), and Tesla (NASDAQ: TSLA)—make up a disproportionate share of major indices like the S&P 500 and MSCI World.

This concentration can expose investors to sector-specific risks, reduce diversification, and amplify volatility during downturns.

A solution: a smarter passive SMA

To address this, a passive SMA model could incorporate:

• Smart beta ETFs, such as equal-weight strategies that reduce the dominance of large-cap stocks like CBA.

• Low-cost active managers, selected for their ability to diversify away from index-heavy names while maintaining benchmark awareness.

• Traditional index funds, providing broad exposure at minimal cost.

This blend allows investors to maintain the core benefits of passive investing - low fees, simplicity, and market exposure - while mitigating the structural risks of index concentration.

Portfolio construction and management

A passive SMA portfolio might typically include:

• Australian equities via a mix of broad-market and equal-weight ETFs. Blackrock has a Top 20 ASX offering iShares S&P/ASX20 ETF (ASX: ILC), you can utilise Betashares Australia 200 ETF (ASX: A200) within your SMA, and also add ETFs like VanEck Australia Equal Weight ETF (ASX: MVW) to try and reduce your concentration risk

• Global equities through index funds and active managers with a disciplined, low-cost approach. We have traditionally used Vanguard MSCI Index International Shares ETF (ASX: VGS) here as well as VanEck MSCI International Quality ETF (ASX: QUAL), and added a relatively low-cost active manager here to reduce concentration risk.

• Fixed income and cash allocations for stability and liquidity, depending on the investor’s profile. Allocations here are to floating rate strategy Betashares Australia Bank Senior Floating Rate Bond ETF (ASX: QPON), Franklin Australian Absolute Return Bond Fund and Vanguard Global Aggregate Bond Index. Passive fixed income can be scary in this environment so we have again tried to reduce swings in capital by shortening duration exposure.

Portfolios are typically rebalanced quarterly to reflect index changes, maintain target weights, assess performance, risk, and manager alignment.

Why SMAs are ideal for passive strategies

SMAs offer several advantages over traditional passive vehicles like ETFs or managed funds:

• Transparency: Investors can see exactly what they own.

• Tax efficiency: No embedded capital gains and the ability to manage tax outcomes more precisely.

• Flexibility: Portfolios can be tailored to investor goals, risk tolerance, and investment horizon.

Final thoughts

Passive investing doesn’t have to mean passive risk-taking. 

By combining smart beta strategies and low-cost active managers within an SMA structure, investors can track the market intelligently - avoiding the pitfalls of concentration while preserving the simplicity and efficiency that passive investing is known for.

If you’re looking for a passive strategy that’s built for today’s market realities, SMAs offer a compelling solution.

In the final part of the series, I’ll discuss all your SMA questions with Livewire’s James Marlay. Please comment on this article with any of your questions for us to cover. 

For the previous wire in this series, click below.

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