This year’s annual rebalancing of the FTSE Russell’s stock indexes, when companies are added or kicked out of the equity gauges, will be a headache for active portfolio managers.

The reconstitution will increase the concentration of the top 10 largest companies in the large-cap Russell 1000 Index (ticker RIY) to a historical high of 29%, according to data from Wells Fargo & Co. That will effectively increase the relative tech underweight for most active managers, who are already struggling to keep pace with the megacap-driven gains in the broad equity benchmarks.

“This creates a bit more risks for active managers,” Chris Harvey, the firm’s head of equity strategy, said. “Another issue portfolio managers are confronting is diversification especially on the large cap growth side. When over 50% of a portfolio or a fund is in 10 names it complicates the diversification effort on multiple fronts.”

Approximately $12.1 trillion is currently benchmarked to FTSE Russell indexes, including the all-cap Russell 3000 and the small-cap Russell 2000. The rebalancing will throw more weight behind megacap names like Nvidia Corp. and Microsoft Corp. that have led markets higher this year, fueled by the artificial intelligence hype. As it stands, the Russell 1000’s biggest 10 names comprise nearly 28% of the index.

The problem is active managers typically run with a small-cap bias, according to Harvey. So the heavier the tech weightings are, the bigger of a “liability” they become.

Year-to-date, the tech-heavy Nasdaq 100 has soared some 38%, handily beating the benchmark S&P 500 Index’s 14% climb. The most underweight megacap firms by the largest active managers are Apple Inc., Tesla Inc., Inc., Nvidia and Microsoft, according to data as of May 22 from Credit Suisse Group AG.

“In terms of active managers, if they’re underweight stocks that are outperforming the rest of the markets, they’re going to underperform the benchmark,” Catherine Yoshimoto, director of product management for the Russell US Indexes, said in an interview.

Since the preliminary list of changes was announced last month, companies expected to be added to the Russell 1000 Index have gained 4.9%, while the deletions have climbed 11.3%, according to data compiled by Wells Fargo’s trading desk on Wednesday.

Nine companies, including Coupang and Ferguson, will be added to the Russell 1000 and 25 firms will migrate from the Russell 1000 to the Russell 2000 on June 23 after market close.

The Russell 1000 Growth Index (RLG) will also see concentration of its top 10 constituents rise to a historic high of 53%, according to Wells Fargo. The index’s exposure to communication services companies like Meta Platforms Inc. will increase. Elsewhere, the Russell 1000 Value Index (RLV) will see its concentration of its largest 10 stocks slightly reduced from 19% to 17% as Meta and Alphabet Inc. leave the benchmark and shift into growth.

Following the rebalancing, Harvey expects large-cap fundamental growth and large-cap quant growth portfolio managers to flip from overweight communications to underweight, largely driven by Meta’s “upsizing” in the growth index.

--With assistance from Sam Potter.

This article was provided by Bloomberg News.