Passive Investing Is an Active Decision: A Look Inside Index Construction
Dallas, Texas — The debate most investors are still having is active versus passive. We think that framing is out of date.
Indexes have proliferated over time and grown considerably more complex. Each provider applies its own eligibility screens, style definitions, size segments, and reconstitution rules. Those choices are not neutral. They determine which companies a portfolio owns and at what weight — and in concentrated markets, they can drive materially different outcomes for two strategies that appear identical on paper.
In a new white paper, we compare equity index construction methodologies across three major providers — FTSE Russell, S&P, and MSCI — and examine what those differences mean in practice. The central argument is straightforward: selecting a passive strategy should be an intentional active decision designed to meet client objectives and outcomes, not simply to mirror a predefined, rules-based index.
Two “Value” Funds, Two Very Different Portfolios
Consider two widely held US large-cap value ETFs. One tracks the Russell 1000 Value Index; the other tracks the S&P 500 Value Index. Both claim the same market segment and the same investment style. Only five of their top ten holdings overlap.
A few observations are worth sitting with. Technology — conventionally considered a growth sector — is the highest-weighted sector in the S&P 500 Value Index and the second highest in the Russell 1000 Value Index. Amazon, a Magnificent 7 constituent, is the top or second-largest holding in both “value” indexes. Microsoft represents roughly 4% of the Russell 1000 Value Index.
Over the trailing one-year period ending June 30, 2026, the iShares Russell 1000 Value ETF returned 26.9% while the iShares S&P 500 Value ETF returned 18.1% — a performance variance of 8.7% between two funds representing the same segment and style.
Style Overlap: When the Same Stock Is Both Growth and Value
Russell assigns style as a continuum rather than a binary. A single stock can be classified 60% growth and 40% value, appearing in both indexes simultaneously. Apple and Microsoft each sit in the top ten holdings of both the Russell 1000 Value and Russell 1000 Growth indexes at similar weights.
The top three positions in the Russell 1000 Value Index — Amazon, Apple, and Microsoft — together represent approximately 15% of the index. Prior to the most recent reconstitution, their combined exposure was modest.
Concentration, in other words, is now an index design issue rather than merely a market-cap effect. Growth indexes are the more extreme case: Nvidia alone represents roughly 14% of the Russell 1000 Growth Index, whose top ten holdings total 54.4%. The corresponding ETF’s own prospectus classifies it as a non-diversified fund.
Forced Equalization: Why a Value Index Keeps Absorbing Growth Stocks
Russell targets a 50/50 split of the parent index’s market capitalization between its growth and value benchmarks. Without that forced equalization, the growth index would be substantially larger than the value index.
The mechanical consequence: as capitalization concentrates in AI and technology names, stocks migrate into the value index to keep the two halves balanced. The gap between the number of holdings in the Russell 1000 Value Index and the Russell 1000 Growth Index now sits at a historically wide level — the last comparable period was the dot-com era. Given its current composition, the value index may no longer be as representative of traditional value as its name suggests.
Reconstitution: Risk Profiles That Change Overnight
Indexes are moving targets, particularly during volatile and concentrated markets. The June 2026 Russell reconstitution was among the more consequential in the provider’s history. Apple, Amazon, and Microsoft were materially added to the Russell 1000 Value Index, while Alphabet moved entirely to the Russell 1000 Growth Index and was a large removal from value.
These changes reflect the index’s methodology — not any recent transformation in the underlying companies. Investors holding passive Russell strategies saw their risk profiles change overnight without taking any action themselves.
Three Percent of the Weight, Twenty-Five Percent of the Return
During the second quarter of 2026, Micron and Sandisk together represented 3% of the Russell 1000 Value Index’s weight but contributed 25% of its total return. At reconstitution, both were moved out of the value index and into the growth index — after that run-up had already occurred.
This is what a narrow market looks like from inside a passive vehicle. Two positions drove a quarter of the return, and then the methodology reassigned them elsewhere.
The Value Index That Outperformed Because of Technology
Year-to-date through June 30, 2026, the Russell 1000 Value Index returned 16.2% against the Russell 1000 Growth Index at 5.3%. The intuitive explanation would be a rotation into traditional value sectors such as Financials. The actual driver was Technology.
During that period, the Russell 1000 Value Index’s Technology sector — roughly a 14% weight — was up approximately 89%. The Russell 1000 Growth Index’s Technology sector, at roughly a 50% weight, was up approximately 8%. The total return impact was roughly an eight-percentage-point outperformance for the value index, despite its relative underweight.
Investors seeking traditional value exposure instead received high-beta momentum volatility — which happened to break in their favor this time. Style indexes, at times, are not as they appear.
Emerging Markets: One Country, a 16.5% Gap
The same dynamic appears internationally, driven by something as fundamental as country classification. MSCI classifies South Korea and Poland as emerging markets. FTSE classifies both as developed.
Because South Korea is a large equity market with world-class semiconductor companies, its absence from the FTSE emerging markets index effectively redistributes weight across Taiwan, China, India, and Brazil. South Korea represents 23.7% of the MSCI-based ETF and none of the FTSE-based one.
Over the one-year period ending June 30, 2026, the iShares MSCI Emerging Markets ETF returned 44.6% while the Vanguard FTSE Emerging Markets All Cap Index ETF returned 28.1% — a variance of 16.5%, driven substantially by a classification decision.
IPO Inclusion: When You Own It Depends on Whose Index You Track
Providers also differ on how and when new listings enter an index. SpaceX — the largest IPO in history — illustrates the spread. FTSE Russell would likely include it roughly five trading days after the IPO, MSCI roughly ten, and Nasdaq roughly fifteen. S&P, which does not fast-track IPOs, would likely not include it for more than a year.
What This Means for Portfolio Construction
A passively managed strategy built to replicate an index may, in practice, represent a poorly defined portfolio. Indexes are designed to represent market segments. They are not designed around risk exposure or reasonable portfolio construction principles, and they were never intended to be.
Many investors treat passive investing as taking a neutral position, and in doing so accept an index’s structural biases. A passive approach is index-centric: it emphasizes and answers the question of which market segment should be represented.
We take a differentiated, intentional, and more deterministic approach that is portfolio-centric, emphasizing and answering a different question: how should an investor’s capital be allocated? We evaluate both active and passive strategies through the perspectives of expected risk, return, diversification, quality, and valuation — seeking to construct portfolios purposefully designed to improve long-term outcomes rather than simply replicating indexes.
Wealth managers and family offices should evaluate indexes and benchmarks as ecosystems, accounting for style overlap, sector exposure, and mega-cap concentration. Understanding these dynamics is critical for manager evaluation, portfolio construction, and risk governance — and especially so when selecting passive strategies.
To request the full white paper, or to discuss how we evaluate passive and active strategies for client portfolios, please contact us.
Sources: FTSE Russell; S&P Dow Jones Indices; MSCI; BlackRock ETFs; Vanguard ETFs; Bloomberg; FactSet; MFS; Jefferies Research; Barrow Hanley; Harbor Capital. Index and ETF data as of June 30, 2026.
Important Disclosure: The views expressed herein reflect our opinions as of the publication date and are subject to change without notice. This material is provided for informational and educational purposes only and should not be construed as investment advice or a recommendation to buy or sell any security or adopt any particular investment strategy. References to indexes and ETFs are for illustrative purposes only. Indexes are unmanaged and cannot be invested in directly. Past performance does not guarantee future results. © 2026 True North Advisors, LLC. All Rights Reserved.