The Big Risk Lurking in U.S. Index Funds Right Now

The big risk lurking in U.S. index funds right now is not some secret scandal. It’s plain old concentration, dressed up in a very expensive suit. A huge slice of popular U.S. indexes now rides on a small group of mega-cap tech names, many tied to the artificial intelligence (AI) trade. If those few names stumble, the whole “diversified” index can feel a lot less diversified.

The second layer of risk hits Canadians in particular. Currency swings and hedging choices can change your experience even when the underlying U.S. market does exactly what you expected. Put it together and you get an index fund that can look calm on paper, then punch harder than you wanted when sentiment flips. So, what should investors do?

Consider an ETF

The BMO Nasdaq 100 Equity Hedged to CAD Index ETF (TSX:ZQQ) gives you targeted exposure to the Nasdaq-100, while trying to smooth out the CAD/USD ride. It aims to replicate the performance of the NASDAQ-100 Index hedged to Canadian dollars, net of fees, and it holds 100 of the largest non-financial companies listed on Nasdaq. That “non-financial” detail matters as it naturally pushes the portfolio toward technology, communication services, and consumer brands, not banks.

Tech and AI-linked mega caps continued to dominate the conversation, and ZQQ simply reflected that. The ETF’s top 10 holdings included Nvidia, Apple, Microsoft, Alphabet, Broadcom, and Amazon, and the top 10 made up 55.7% of the portfolio. That is the concentration risk in one clean number. When more than half your fund sits in 10 companies, the word “index” does not automatically mean “safe.”

The “hedged to CAD” part also deserves real respect, as it changes what you are buying. ZQQ tries to minimize foreign-currency fluctuations relative to the Canadian dollar. That can help if the loonie strengthens, as unhedged U.S. funds can lose value in CAD terms even if U.S. stocks rise. But hedging can also dull gains when the loonie weakens, because unhedged investors get a currency tailwind. Hedging also adds its own moving parts through derivatives and rolling contracts, which can create tracking differences versus a plain, unhedged index experience.

Numbers don’t lie

Now look at the recent numbers, because they tell you how this product behaves when the market changes tone. Total value sat at about $2.8 billion at the time of writing, with a management expense ratio (MER) of 0.39%. It also showed the risk rating as medium to high. That rating matches the reality of a concentrated growth-heavy index. It can rip higher, but can also drop fast.

Performance history makes the point without any drama. While the beginning of 2025 saw a major drop, the ETF surged back, and is now up about 10% in the last year alone. Meanwhile, it has been stable year-to-date. That is not a “set it and forget it” fund. It is a “set it and hold on” fund.

The future outlook comes down to whether the same winners can keep delivering. ZQQ will likely keep benefiting if AI spending stays robust and the biggest platform companies keep compounding earnings. The flip side sits in the same place. If the market decides those mega caps look too pricey, or if regulation, competition, or a slowdown hits the narrative, the concentration can amplify the pain.

Bottom line

So could ZQQ be a buy amid the big risk lurking in U.S. index funds? It could, if you want purposeful exposure to U.S. growth leaders and you can stomach medium-to-high volatility without panic-selling. It can also make sense if you prefer to reduce CAD/USD noise inside a Tax-Free Savings Account (TFSA), where you want the return to come mainly from the companies, not the currency.

The reasons it might not be a buy are just as clear. The fund concentrates heavily in a handful of mega caps, and it can drop hard when growth falls out of favour. If you cannot hold through a sharp drawdown, this is not the place to practise courage.

The post The Big Risk Lurking in U.S. Index Funds Right Now appeared first on The Motley Fool Canada.

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More reading

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Fool contributor Amy Legate-Wolfe has positions in Microsoft. The Motley Fool recommends Alphabet, Amazon, Apple, Microsoft, and Nvidia. The Motley Fool has a disclosure policy.