By Tim Courtney, Chief Investment Officer

The S&P 500, especially over the last decade, has become the gold standard of stock indexes in the eyes of many investors. The three largest ETFs are indexed to it, which is by far the most common index available in 401k plans¹. As such, monthly money flows to those 500 companies are massive. Numerous indexing companies and methodologies are available in the market, but none command the attention and licensing fees that the S&P 500 does.

Many describe the S&P 500 as a passive and well-diversified investment strategy. While that has been a mostly accurate description over its many decades of existence, we believe today that it is not as passive or diversified as many think.

The index is passive in making buying and selling decisions based only on the market capitalization (size) of 500 companies, ignoring price and profitability. However, there are elements of active decision-making from the committee that determine which 500 companies are included in the index and how. Sometimes, companies (Tesla and Super Micro Computer are good examples) are not included for years after they become large companies. 

Mainly being a market-cap driven strategy, the S&P 500 holds large weights to the largest and small weights to the smaller companies (the bottom 300 companies make up 14% of the index²). This feature helps the index perform better during periods of market concentration when the largest companies grow fastest to make up an even bigger part of the market. It is abnormal for the market to concentrate as quickly as it has over the last several years, but accelerating concentration has helped the recent performance of the market-cap weighted S&P 500.³

 The S&P 500 now has 37% of its weight in ten companies and has become more dependent on those companies and less diversified.⁴ It also has become more exposed to the risk of market broadening, as it has done following past periods of concentration.⁵ In broadening markets, other weighting strategies, such as equal-weighting, have performed better. Since 1990, when the S&P 500 has been more concentrated than average, the S&P 500 Equal Weight Index has outperformed the S&P 500 by an average of 2.43% annualized over the next five years.⁶

Over an almost 35-year period, the S&P 500 Equal Weight Index has outperformed the traditional S&P 500, even considering the 1990s dot-com run and the last decade of tech dominance. With the S&P 500 more concentrated and expensive than average, there are headwinds to its performance compared to other weighting strategies.⁷

This is not to say that we should completely avoid market-cap weighted strategies, but rather that market cap-weighted indexes like the S&P 500 are not made of a secret sauce and are not without their own set of issues and risks. If you have any questions about this, please contact your Exencial advisor.

Sources:

1. VettaFi (8/23/24) - Largest ETFs: Top 100 ETFs By Assets
2. NerdWallet ( 8/16/24) - S&P 500 Companies: Full List and Performance
3. Investopedia (8/1/24) – Mid-Caps Used To Outperform Large-Caps. What Changed?
4. CNBC.com (7/1/24) – Is the U.S. stock market too ‘concentrated’? Here’s what to know
5. Financial Times (8/6/24) – Investors Brace for ‘Regime Shift’ as Market Volatility Returns
6. Exencial Study (6/30/24) – Concentration data from Morningstar, 1/1990–6/2019. Return data from Morningstar, median 5 year annualized returns from 1/1995–6/2024
7. Morningstar (3/8/24) – Is the Stock Market Expensive Right Now?

PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this article. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information provided in this book. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971. 

The S&P 500® is widely regarded as the best single gauge of large-cap US equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.

The S&P 500® Equal Weight Index (EWI) is the equal-weight version of the widely used S&P 500®. The index includes the same constituents as the capitalization weighted S&P 500®, but each company in the S&P 500® is allocated a fixed weight – or 0.2% of the index total at each quarterly rebalance.