Managing risk in a changing world: how passive investors can address market challenges in 2026

Consistency during volatility

In another turbulent year where markets have seen plenty of changes in direction, the focus at Netwealth remains on taking intentional exposure to different investment markets in a cost-effective way.

There are three pillars to our investment process: building strategic allocations to relevant asset classes according to the long-term client risk appetites, choosing the best instrument to reflect intended exposure, and adjusting portfolio positions on a shorter-term, more cyclical basis.

Daily liquidity is a pre-requisite condition for our investments but is rarely relied on as we recognise the risks of over-trading.

Alongside a keen eye on cost management, risk awareness is at the core of each strand of the process. For this reason, we tend to avoid the pitfalls of selecting active stock-pickers, whose dependence on skill may falter, or whose style may fall out of favour for extended periods of time. This leads us to a so-called ‘passive’ bias in the way we access markets, usually through exchange traded funds (commonly known as ETFs).

Importantly, this doesn’t mean a fire-and-forget approach to our allocations. Rather, it’s a view that the behavioural and cost hurdles are too high for most managers to clear, most of the time. This preference has to date been a significant tailwind to the Netwealth performance over the past ten years.

Ensuring portfolio exposure is intentional is now more important than ever. Against a backdrop of reasonable economic growth and strong corporate profitability, two themes have dominated everything else in markets so far in 2026: geo-political risk from conflict in the middle east and the all-consuming disruption of artificial intelligence. The market’s attention on war and its economic impact via energy costs has been sporadic, but the impact of AI on equity market performance has been durable and intense in recent years, even if it has evolved through time.

Rotation and risk within AI

Market participants are constantly trying to understand who will be the lasting winners and losers of AI, and what began as a rally in hyper-scaler stocks (technology companies who own the core infrastructure layer that enables data processing, model training and enterprise adoption of AI) has broadened across the semiconductor ecosystem, underpinned by a structural surge in demand for the hardware that supports AI activity. Capacity constraints have been creating significant pricing power for a small number of companies crucial to supplying memory power and chip-manufacturing capabilities. Specific companies in the US (Micron Technology), Taiwan (TSMC), and Korea (SK Hynix and Samsung) were previously priced as skilled manufacturers of commodity-like assets, so outsized profits from full order books have seen their share prices skyrocket.

Meanwhile, the market’s view of the hyper-scalers has deteriorated. Previously their expensive valuations were justified as they were seen as the gatekeepers to AI productivity gains, but cracks in the outlook from higher capital expenditure requirements are re-shaping their share price characteristics and have led to a period of poor performance.

The potential use cases and expanding adoption of AI across all walks of life clearly suggest that it will be a relevant market theme for years to come, but it may not prove immune to future challenges. History tells us that when excitement around new technology leads to exuberance, abnormally high profits eventually attract excess capital and disappointing returns for late investors once sentiment weakens. The recent record initial public offering (IPO) and subsequent debt issuance of Space-X, and the forthcoming raises from Anthropic and OpenAI suggest we are no longer early in the AI investment theme, even if AI usage is still growing at a fast rate.

What is the relevance for investors in ETFs?

The performance of any ETF is driven by its underlying assets, so it’s vital to know what is in your portfolio’s holdings, and in this way, there is no such thing as a ‘passive’ decision. Index selection is always important for risk management, and the team are pleased that the S&P 500 Index rules forbade our chosen ETFs from chasing the Space-X share p rice higher.

For the past 2 years, we have sought to manage the impact of market concentration, whereby an index is dominated by the outcomes of its largest components via our ETF selection in the US. More recently, a similar challenge has surfaced in emerging markets. The returns generated by the big three Korean and Taiwanese AI-beneficiaries have led to an outsized position in global emerging markets indices. As seen below, they now represent a bigger allocation than the top ten stocks normally do, and their performance dominates emerging market ETF returns day-to-day.

Source: Bloomberg with Netwealth calculations

Managing the risks

This process has undoubtedly been a positive driver of returns for the Netwealth portfolios – enduring beyond the gains harvested through a cyclical position in the undervalued Korean market last year, but we believe it now needs managing more carefully.

Our response in emerging markets has been to begin to dilute the influence of these current AI ‘winners’ within portfolios. Although their earnings profile remains robust and headline valuations are reasonable as a result, we have helped our strategic market exposure to be more broader-based by including a new holding in Netwealth portfolios. Starting with the same universe of investible stocks, the iShares Emerging Markets Minimum Volatility ETF constructs a strategy with a significantly lower volatility profile, within predetermined constraints on security, sector and country weights. Inherently, the process significantly dials down the allocation to the biggest holdings – especially when they are subject to the same thematic driver of returns. In this way, we believe it complements the clean market exposure of our existing allocations to traditional, market capitalisation-weighted holdings.

Conclusion

Our goal is always to set up the Netwealth portfolios to efficiently deliver the returns that market offers to patient investors. We don’t have a crystal ball on future returns, and we don’t believe other investors do either. However, we do think that considered management of potential market risks should always be front of mind in portfolio construction and will continue to evolve allocations to do so.

To learn more, you can watch Iain Barnes talk through the key themes in this Decade in review webinar.