Schroders Head of Wealth, South Africa, Philip Robotham on exploiting market inefficiencies and why active managers may have the advantage in today’s markets.

While passive investing is a cost-effective way to gain exposure to equity markets, it tends to work well in a calm, trend-driven market environment. At the current juncture of the markets, investors might want to consider an active approach to not only weather current market volatility but find the opportunities in it too.

1. Concentration in the US stock market

Valuation multiples are quite high across all regions, primarily in the US, but equally so in some other pockets of the world. Meanwhile, index concentration is increasing across multiple regions and volatility has picked up so far in 2025. Combining all those three components together, one would advocate that risk management and an ability to tilt away from more concentrated, more valuation stretched pockets to other portions of the market could be prudent. Looking ahead, we think an active approach will be required to navigate these risks.

2. US has driven market concentration to a four-decade high...

…but US market is still not unusually concentrated by global standards

_{Note: On the left-hand chart both the MSCI World and the MSCI AC World indices are included as the former has a longer history while the latter incorporates emerging markets.}

_{Source: LHS: LSEG Datastream, MSCI and Schroders. Data to January 2025. Index: MSCI AC World index and MSCI World Index. Data is monthly with each data point reflecting the percentage weight of the largest 10 stocks in the mentioned index at each respective date.  RHS: MSCI, as at January 2025.}

3. The Mag 7 are facing short-term risks

The Mag 7 are not a homogenous group; each operates very differently, they have different product sets and different priorities. Microsoft is not Apple or Amazon; Google isn’t Meta; Nvidia isn’t Tesla. But the Mag 7 do share one common denominator, which is artificial intelligence (AI). They share a common interest in advancing their platforms through the deployment of generative AI models – essentially revolutionising the process of interaction between humans and computers. Optimism about the implications of this revolution has significantly influenced their stock prices, providing a common performance driver despite the variations in their respective businesses.

At this point the key question is, are investors ahead of their skis? Are they too excited about the AI theme and not thinking about the reality of translating new technology into hard dollars? It's relevant because doubts are creeping in. The doubts are focused on the idea that these companies are spending unprecedented amounts on AI, and yet the short-term revenue benefit and profit benefit is actually very limited. There is a legitimate concern here. While the structural potential from AI is clearly enormous, we suspect there will be major disappointment at some points.

New technologies rarely deploy in a straight line: they take time to build, and there are inevitably speed bumps along the way. We are currently in a period of consolidation, and possibly some real disappointment later this year if demand for AI infrastructure (semiconductors, network equipment) begins to weaken.

4. Taking the harder route to get ahead

Many active managers have been going through an extremely challenging period of history. At the same time, we have seen a rise of passive investing in an environment where some of the largest big tech companies have been doing extremely well. Some of the cheapest passive products that buy all the same stocks are also the ones that in many cases have been seeing strong returns.

Can that environment continue? Based on history, almost certainly not. When you get to this degree of concentration, where more than 30% of the US market is represented by a handful of stocks, historically the market has always broadened out. Those very large companies, as a group, have done relatively less well. Some of them may continue to power ahead, but the law of large numbers dictates that others will struggle to sustain growth and may even begin to decline.

We are entering this new phase. Given that many areas of the equity market have been neglected amidst the euphoria around the AI revolution, a broadening out is an opportunity for active managers. Our new research into changes both in the structure and participants in stock markets suggests that there may therefore be greater opportunities for active managers to outperform in the future than in the past.

No matter which region of the world or economic sector of the market, companies that deliver revenues, cash flows and ultimately earnings above the level anticipated by the market are well placed to deliver superior share price performance over time. Fundamental stock research and analysis should focus on identifying those companies able to deliver positive earnings surprises, or which have a positive "growth gap", which the market often fails to recognise. Even in the most efficient market in the world (the United States) these inefficiencies with respect to future growth are prevalent and often persistent. Typically, higher growth characteristics are eventually recognised by the market, which often places higher valuation multiples on those earnings at the same time.

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