Much of last year’s 26% gain in the
SPDR S&P 500
exchange-traded fund was due to the stellar performance of the Magnificent Seven—the mostly tech-stock behemoths that are the index’s biggest holdings.
If those stalwarts stumble, expect an outsize negative impact on the market-cap-weighted index, as
Apple,
Amazon.com,
Alphabet,
Meta Platforms,
Microsoft,
Nvidia,
and
Tesla
account for more than one-quarter of the
S&P 500’s
market value. Given the concentration risk, some investors are looking at incorporating equal-weight index funds to diversify.
Equal-weight strategies take a democratic view of the market, giving equal weight to each component. Reshuffling the S&P 500 that way relegates each company to a 0.2% slice of the index, tilting it to value-oriented and mid-to-smaller-cap stocks and away from large-cap growth.
The market-cap-weighted S&P 500 currently mirrors 45% of the Nasdaq 100, double what it was 10 years ago, says Nick Kalivas, head of factor and core equity product strategy at Invesco. Last year’s rally pushed the index’s top 10 holdings to 32% of total weight, up from 25% at the start of 2023. Invesco issues the $49.6 billion
Invesco S&P 500 Equal Weight
ETF, the largest such fund by assets.
With the market-cap S&P 500 so top-heavy and growth-focused, investors are seeking alternatives. “It has opened the door for equal weighting, where you’re still getting all 500 stocks,” Kalivas says, pointing to average annual inflows of $5.3 billion the past five years into the equal-weight S&P 500 ETF and another $616 million in flows so far this year through mid-January.
Matt Dmytryszyn, chief investment officer at financial advisory Telemus, is considering the Invesco fund for client portfolios. He’s also intrigued by its lower valuation, citing the standard S&P 500 is trading at 19.6 times 2024 earnings versus the equal-weight index’s 16.1.
John Davi, CEO of Astoria Portfolio Advisors, is adding several equal-weight index ETFs to client portfolios. He believes potential Federal Reserve rate cuts will usher in a new market cycle, requiring a different strategy. Among the ETFs he’s using are the $3.5 billion
Invesco S&P 500 Equal Weight Technology
ETF and the $530.7 million
Invesco S&P 500 Equal Weight Energy
ETF.
“If the Fed cuts rates, there’s a new cycle. [If there’s] no more earnings recession, why not diversify to the mid-cap range of these sectors?” Davi asks.
Because of equal-weight strategies’ small- and mid-cap tilt, they generally perform well during accelerating profit growth, Kalivas says.
Early market action in 2024 suggests a broader number of large-cap winners. Daniel Milan, chief investment officer at Cornerstone Financial Services, says an ETF such as the $2.3 billion
First Trust Nasdaq-100 Equal Weighted Index
could give investors broader technology exposure.
Equal weighting can be applied to any sector or country index, though the strategy’s benefits are most apparent in large-cap indexes. Investors should consider replacing about one-third of their large-cap weighted ETFs with equal-weight ETFs to diversify their core holdings, Davi and Milan suggest.
Keep in mind these are long-term strategies, as short-term return differences can be stark. Last year, when the SPDR S&P 500 ETF gained 26%, Invesco S&P 500 Equal Weight rose 13.7%, according to Morningstar. However, equal weight outperforms over time. Research from S&P Dow Jones shows the S&P 500 Equal Weight Index had an 11.5% return over the 20 years through 2023. The market-cap weighted S&P 500 returned 10.3% over that period.
“If you’re going to do equally weighted indexes, you have to commit to it,” Milan says.
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