The rise of AI vs the case for genuine diversification

Damon Frith, Wealth Editor | NAB Private Wealth

Passive investing in the S&P 500 has been one of the most successful and accessible wealth-building strategies of recent decades. Low costs, broad exposure and automatic participation in the growth of leading US companies have rewarded investors who stayed invested through market cycles.

Over the 3.5 years to June 2026, the S&P 500 Index delivered an annualised total return of approximately 22.4%. Over the same period, the S&P/ASX 200 Index returned about 9.4% a year, according to NAB research.

The long-term record is equally compelling. An AUD10,000 investment in the S&P 500 at the beginning of 1985, with dividends reinvested, had grown to approximately AUD921,000 by March 2025, equivalent to an annualised return of about 11.8%. The same starting amount invested in Australian shares had grown to about AUD580,000 over the same period, according to NAB research. These comparisons reinforce the benefits of long-term equity ownership, although past performance is not a reliable indicator of future returns.

Outstanding returns, but a different index

However, tracking the S&P 500 has increasingly become a sizeable allocation to a small group of mega-cap companies. That concentration helped drive returns while market leadership remained strong. It also means future outcomes are more dependent on the earnings, valuations and investment spending of relatively few businesses.

Why index concentration matters

By June 2026, the ten largest S&P 500 holdings represented about 37% of the index. Several of the biggest Index constituents - including Nvidia, Microsoft, Apple, Amazon, Alphabet, Broadcom and Meta – are central to the AI ecosystem through chips, cloud computing, digital platforms or capital spending on AI infrastructure.

It does not make the S&P 500 a pure AI investment, but a substantial share of its performance is increasingly tied to a common theme: continued spending on AI capacity and the ability of a small group of companies to convert that investment into durable earnings.

The trend is further reinforced by the mechanics of market-capitalisation weighting. As a company’s value rises, its index weight rises and passive funds allocate more capital to it. It means investors can increase their exposure to the largest and best-performing companies without making an active decision to do so.

Concentration is not unique to the United States. Australia’s benchmark is heavily influenced by banks and miners, while Taiwan and South Korea carry large weights in leading semiconductor companies. The difference is thematic: US and several Asian indices are increasingly concentrated around the same AI and semiconductor investment cycle, while Australia’s concentration remains more sector based.

Owning more indices may therefore create less diversification than expected. A portfolio combining an S&P 500 fund, a global developed-markets fund and a technology fund can hold many securities while repeatedly allocating to the same large US companies.

Diversification remains the bedrock

Diversification has never been designed to ensure a portfolio owns every winner at its maximum weight. Its purpose is to reduce dependence on any single company, sector, country, investment style or economic outcome.

That principle matters when a narrow group of assets produces exceptional returns. Diversifying at such times can feel uncomfortable because it may reduce exposure to recent winners. But the objective is not to predict when leadership will change. It is to build a portfolio that does not require one outcome to continue indefinitely.

A genuinely diversified portfolio combines assets with different underlying drivers. This may include equities across regions and sectors, high-quality fixed income, infrastructure, real assets, private markets and cash. Within equities, it may also involve balancing market-cap-weighted exposure with active, equal-weighted, factor-based or smaller-company allocations, where appropriate.

Maintaining AI exposure through a broader opportunity set

Reducing reliance on a handful of index leaders does not require abandoning the AI theme. AI is not just a story about AI model developers and mega-cap technology platforms. Its expansion depends on a much broader physical and commercial ecosystem.

1.     The physical infrastructure behind AI

Data centres require land, reliable electricity, grid connections, cooling, fibre networks, storage and specialised equipment. Infrastructure, utilities, electrical equipment, data-centre property and connectivity businesses can provide exposure to AI-related investment without simply increasing the weight of the largest platform companies.

2.     The semiconductor supply chain

AI computing relies on more than leading chip designers. Foundries, memory producers, networking companies, semiconductor equipment manufacturers, testing businesses and advanced packaging suppliers all participate in the build-out. Exposure across the supply chain can reduce reliance on a single company, although the industry remains cyclical and interconnected.

3.     Businesses applying AI to lift productivity

The next phase of value creation may extend from companies supplying AI to those using it effectively. Healthcare, industrial automation, logistics, financial services, cybersecurity and professional services may benefit if AI lowers costs, improves decisions or creates new products. This broadens the opportunity beyond the companies currently dominating the benchmark.

4.     Active and differently weighted equity strategies

Active managers can choose where along the AI value chain to invest and can limit positions when valuations or portfolio weights become excessive. Equal-weighted, value, quality and smaller-company strategies can also reduce dependence on the largest index constituents, although each introduces different risks and may lag a cap-weighted benchmark for extended periods.

5.     Private markets

Private infrastructure, private equity and venture capital may offer access to businesses and assets unavailable in listed markets. But private does not automatically mean diversified. Investors need to look through the label to the underlying exposure, especially where private portfolios are also heavily allocated to AI software, data centres or the same technology spending cycle.

A portfolio framework, not a rejection of passive investing

Passive funds remain useful building blocks. They provide low-cost market exposure, transparency and discipline, and their long-term success should not be dismissed. The issue arises when several passive holdings create an unintended aggregate bet on the same companies and theme.

Investors can manage that risk by looking through every fund to its largest holdings, measuring overlap across indices, setting limits for single companies and sectors, and rebalancing when market gains push exposures beyond their intended range. They should also distinguish between an allocation to US equities and an allocation to the AI trade: today, the two overlap more than many portfolio labels imply.

The aim is not to eliminate exposure to successful companies or to predict the end of AI-led market leadership. It is to retain participation in a powerful structural theme while ensuring the broader portfolio can withstand a slowdown in AI spending, valuation compression, stronger competition or a change in market leadership.

Conclusion

The S&P 500’s exceptional record shows why passive investing has become a core strategy for many investors. But the index has changed: a growing share of its value and returns now rests on a small group of companies linked to the AI build-out.

Diversification remains the bedrock of a resilient investment portfolio because it limits dependence on any one forecast. Investors can maintain meaningful AI exposure through public and private infrastructure, the semiconductor supply chain, AI adopters, active strategies and differently weighted markets - without allowing a few overlapping index positions to determine the outcome of an entire portfolio.

*All historical S&0P 500 figures sourced from Bloomberg.

Analysis as at 31 August 2026. This information has been prepared by National Australia Bank Limited ABN 12 004 044 937 AFSL 230686 ("NAB"). The content is distributed by WealthHub Securities Limited (WSL) (ABN 83 089 718 249)(AFSL No. 230704). WSL is a Market Participant under the ASIC Market Integrity Rules and a wholly owned subsidiary of National Australia Bank Limited (ABN 12 004 044 937)(AFSL No. 230686) (NAB). NAB doesn’t guarantee its subsidiaries’ obligations or performance, or the products or services its subsidiaries offer. This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. Past performance is not a reliable indicator of future performance. Any comments, suggestions or views presented do not reflect the views of WSL and/or NAB. Subject to any terms implied by law and which cannot be excluded, neither WSL nor NAB shall be liable for any errors, omissions, defects or misrepresentations in the information or general advice including any third party sourced data (including by reasons of negligence, negligent misstatement or otherwise) or for any loss or damage (whether direct or indirect) suffered by persons who use or rely on the general advice or information. If any law prohibits the exclusion of such liability, WSL and NAB limit its liability to the re-supply of the information, provided that such limitation is permitted by law and is fair and reasonable. For more information, please click here.