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Bailey McCann, Opalesque New York:

New research out from $9 billion, French asset manager TOBAM suggests that the rally in financials during the second half of 2016 may be an example of index concentration putting more pressure on passive products than investors realize.

According to a research note from TOBAM founder Yves Choueifaty, during the rally, financial sector concentrations in the MSCI index hit levels that actually increased risk exposure and decreased overall diversification within the index. "What happens is the index encourages investors to buy when the asset class is the most expensive," Choueifaty, explains in an interview with Opalesque. "What we want to point out is that when you buy a market cap weighted index you aren't actually buying as much diversity as you might expect."

Choueifaty notes that over time the MSCI index universe has become more correlated, a development which could be worrying if you aren't consistently bullish or assume that there is some level of downside protection in the perceived diversity of the broad index.

The image below shows how those correlations have grown closer over time:

Choueifaty says that the correlations outlined above haven't been seen since 2008 and may be a cause for concern. "Financials are the most highly correlated sector to the rest of the market and they are now very expensive. Buying the index after December 2016 ......................

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