Investors are showing a growing interest in a modified S&P 500 stock-market strategy as concerns over concentration risk rise. Index funds have long been favored by investors due to their low expenses and consistent performance, especially when compared to actively managed funds. However, the success of these funds has led to an increased concentration in certain companies, which poses a potential risk. One such fund, the SPDR S&P 500 ETF Trust, has seen its top five holdings make up 24% of its portfolio, while the top 10 holdings make up 31.6%.
Lisa Shalett, Chief Investment Officer at Morgan Stanley Wealth Management, noted that this level of concentration is higher than during the tech bubble of 1999-2000 and the historical average over the past 35 years. This means that investing in a market-cap-weighted S&P 500 fund is increasingly dependent on the performance of just a few companies, with the fundamentals of the other 490 companies carrying less weight.
As a result, investors are now turning their attention to alternative strategies that offer a more balanced approach. One such strategy is the Invesco S&P 500 Equal Weight ETF, which has seen $4.8 billion in new investments over the past five weeks. This represents 14.9% of the fund’s assets under management as of May 19. In contrast, the inflows for the SPDR S&P 500 ETF Trust and the SPDR Portfolio S&P 500 ETF, both of which are cap-weighted, were 1.8% and 4.1% respectively.
The Invesco S&P 500 Equal Weight ETF takes a different approach by assigning an equal weight to all 500 stocks in the S&P 500 index. This means that no single company dominates the portfolio, reducing the concentration risk. Nick Kalivas, Head of Factor and Core Product Strategy for ETFs and indexes at Invesco, explained that the equal-weighted approach is underweight in the information technology sector compared to the cap-weighted index, but overweight in other sectors such as industrials, real estate, materials, utilities, and financials.
While the equal-weighted approach may be more volatile due to its exposure to smaller companies, it has outperformed the cap-weighted approach in terms of total returns over the past three years. This is particularly noteworthy considering the recent tech rally, during which the equal-weighted approach was able to come out on top. Kalivas attributes this outperformance to the periodic rebalancing of the fund, which helps it buy low and sell high.
Investors are increasingly realizing the benefits of a diversified and balanced approach to investing. While index funds have historically been a safe and reliable choice, the concentration risk inherent in these funds has sparked interest in alternative strategies such as the equal-weighted approach. By allocating an equal weight to all companies in the index, investors can reduce the reliance on a few dominant companies and potentially achieve better long-term performance.
