Index construction: Constant concentration portfolios (Part 2)

In stable market phases, market capitalization-weighted indices are a proven portfolio basis – successful companies of the past often remain successful in the future. However, we may be living in an era of structural disruption: Authoritarian mercantilism is calling globalization into question, geopolitical tensions threaten access to raw materials and critical infrastructure, while technological revolutions (AI, quantum computers, fusion) could shake traditional business models.

The problem: Many equity indices today exhibit an "absurd concentration" on a few companies that have primarily benefited from the past 10-15 years – a trend that may not continue. These index structures harbor massive implicit bets that should be avoided.

In the first part of the series, a square root weighting was already introduced as an alternative to traditional market capitalization weighting to reduce concentration. The second part now goes a step further: Since square root weighting still contains arbitrary elements and does not allow direct influence on the concentration measure of the index, the concept is being developed into a method that allows for targeted control of a desired concentration measure and thus conscious control over portfolio risks.