What’s underneath for index investors? Alan Dobbie, Fund Manager of the Rathbone Income Fund says there’s opportunity beneath the surface.
For much of the past decade, it has been easy for investors to dismiss UK‑focused equity funds. Political noise, persistent fund outflows and weak relative performance made the market an obvious one to overlook. In 2025 and early 2026, however, the mood began to shift.
Rising political volatility in the US, combined with still-reasonable UK valuations, reminded investors of the benefits of diversification. UK equities appear to be back on the radar.
Yet many who have taken a fresh look have reached a familiar conclusion.
With only around a fifth of funds in the IA UK Equity Income or IA UK All Companies sectors beating the FTSE All‑Share over the past five years, why not simply buy a tracker? The index seems to offer the simplest, lowest‑effort solution.
The problem is that the UK’s benchmark index masks a growing and underappreciated risk: concentration.
An index dominated by very few stocks
The FTSE All‑Share contains more than 500 companies, but today just 13 stocks account for half of the index’s value. Five years ago, the top 13 made up just over a third.
That represents a material change in market structure over a relatively short, albeit eventful, period.
If you’re accessing UK equities via passive funds, you should recognise that you are now making a sizeable implicit bet on the future performance of a very small group of companies.
This concentration has had clear consequences. Over the past five years, these same 13 stocks were the dominant drivers of FTSE All‑Share returns, delivering an average gain of 143%.
By contrast, the remaining 516 stocks in the index have risen by just 12% on average. The UK market has become increasingly uneven, with returns concentrated in a handful of large names.
That goes a long way towards explaining why active managers have struggled.
Beating a benchmark powered by a small number of very large, strongly performing stocks is inherently difficult, particularly for managers unwilling to take the stock‑specific risk associated with running 7–8% positions in names such as AstraZeneca, HSBC or Shell.
We simply can’t take those punchy, risky single-stock bets that the index takes in its sleep.
From deeply unloved to rerated
It’s worth looking more closely at these 13 stocks and understanding where their strength has come from. This is not a ‘nifty‑fifty-esque’ group of high‑quality, buy‑and‑hold‑forever businesses.
Instead, it includes two banks, four commodity‑linked companies, a tobacco stock, a defence business, and a company that reported losses for three consecutive years before COVID struck.
Five years ago, sentiment towards many of these stocks was extremely poor. Banks were constrained by ultra‑low interest rates and heavy regulatory pressure.
Energy companies were widely viewed as structurally challenged, even facing terminal decline.
Tobacco was written off as ex‑growth. Defence stocks, at least before Ukraine, were seen as dull, low‑growth yield plays. Valuations reflected this scepticism.
Since then, the backdrop has shifted materially. Interest rates have risen, geopolitics has become more unstable and energy security has moved firmly up the agenda.
These companies have benefited from a powerful change in narrative, strong cash generation and generous capital returns to shareholders. Valuations have moved to reflect those changes.
Banks now trade at clear premiums, rather than deep discounts, to tangible book value.
Defence stocks such as BAE Systems trade on around 24x forward earnings, not 10x.
And while British American Tobacco’s roughly 12x forward earnings multiple may not appear demanding in absolute terms, it is almost double the rating at which the stock traded as recently as two years ago.
For passive investors, the key point is that more than half of their UK equity exposure is now anchored in stocks that have already experienced a substantial rerating.
It seems unlikely that fundamentals, sentiment and valuation will provide the same tailwinds over the next five years as they did over the previous five.
What this means for index investors
The implications of this concentrated structure are straightforward.
Strong recent index performance, combined with widespread active underperformance, has made passive strategies appear to be the lower‑risk option.
But that impression is shaped by what has already happened, largely a one‑off rerating from very depressed starting points, supported by shifting narratives.
Momentum could persist, particularly if liquidity considerations continue to funnel capital towards the largest names. Crowded trades often last longer than expected.
However, when more than half of an index depends on just 13 stocks, the margin for error narrows.
Any earnings disappointment, regulatory change or sector‑specific shock would have a disproportionate impact on overall index returns.
Opportunity beneath the surface
The flipside of concentration is opportunity. While the largest stocks have surged, much of the rest of the market has been left behind.
Five years of largely flat performance across more than 500 companies has inevitably created anomalies.
Many of these businesses are smaller, less liquid and unfashionable. As a result, valuations in some parts of the market already discount a great deal of bad news.
Balance sheets are often robust and underlying operational performance more resilient than share prices suggest.
This is where active management should once again play a role.
The sources of return in the FTSE All‑Share over the next five years may look very different from those that have driven performance over the last five.
While calling turning points is always risky, it may now be more productive to reassess where future opportunities lie, rather than continue to rely on what has worked in the recent past.
Main image: UK, alev-takil-7ojyp-IXW7w-unsplash
