Thanks to the success of FAANG stocks – Meta Platforms Inc (FB), Alphabet Inc (GOOG), Amazon.com Inc (AMZN), Netflix Inc (NFLX) and Apple Inc (AAPL) – and other heavyweights such as Microsoft ( NASDAQ: MSFT) and Tesla (NASDAQ: MSFT), the concentration of S&P 500 returns has been quite concentrated in recent years.
Put simply, a small number of stocks represented a significant percentage of the returns of a supposedly large stock index. It’s good when things work out and those names don’t encounter specific company head winds. However, if one or two of the biggest names in the cap-weighted S&P 500 are affected, that bad news can trickle down to the index as a whole.
Such a scenario highlights the advantages of equal-weight exchange-traded funds like the Invesco S&P 500 Equal Weight ETF (RSP).
“In 2020, the concentration of stock returns peaked amid pandemic-induced volatility,” according to Morningstar. “But the trend in 2021 has shifted towards a lesser degree of concentration of returns. For investors, this is a potentially healthier dynamic, with less risk for index funds and more opportunities for stock pickers.
Of course, it is positive that the concentration of returns in the S&P 500 decreases a bit, but the point is that the three major components of the capitalization-weighted S&P 500 (Apple, Microsoft and Amazon) combine for more than 17 % of the reference weight. It is strong concentration. Conversely, RSP’s top 10 holdings make up about 3% of RSP’s list. This decreases the concentration of return and the risk of concentration.
“Relaxing focus is good for investors and the health of the market,” said Dan Kemp, global investment director at Morningstar Investment Management. “Concentrated portfolios tend to be less resilient to a change in the economic environment and have to fall further in the event of unexpected headwinds due to their high valuations. “
Nonetheless, the top five stocks of the major capitalization-weighted market benchmarks are showing above-average contributions to market returns this year. Add to that, most of these names don’t come cheap. Some are highly regarded, potentially highlighting the value proposition offered by equal weight strategies.
To this end, RSP allocates 37% of its weight to value stocks.
“Market concentration peaked in 2020 when the top five holdings alone contributed almost 40% of market performance for the year. This year, the top five stocks were responsible for 8% of market performance, while the top 10 stocks contributed a total of 20%, ”notes Morningstar.
These data points could indicate that investors looking for true diversification might consider RSP.
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The opinions and forecasts expressed herein are solely those of Tom Lydon and may not come to fruition. The information on this site should not be used or interpreted as an offer to sell, a solicitation of an offer to buy or a recommendation for any product.