In 1H 2024, just 3 stocks drove 49% of the S&P 500 gains. These three stocks are Nvidia, Alphabet, and Microsoft.
If you are looking at the Magnificent Seven (Microsoft, Apple, Alphabet, Nvidia, Amazon, Meta, Tesla), they account for roughly 35% of the S&P 500 in terms of market cap.
This brings to question if such high weightage on a few megacaps expose the average investor to more idiosyncratic risks than needed.
Unlike a Market Cap-weighted index/ETF which has concentration risk, an Equal Weight ETF does not have any of these risks.
A S&P 500 Equal Weight ETF will have each of the constituents in the index given a similar weightage. This means that the performance of the Magnificent Seven has an equal impact as any other seven companies in the index on the overall ETF's performance.
Just last month, the S&P 500 Equal Weight Index outperformed the S&P 500 by 3%. This happens as a result of sector rotation as the performance of the Magnificent Seven trails the remaining index.
However, it's not just last month that the S&P 500 Equal Weight Index outperformed the S&P 500.
If we looked back at history, there are multiple time periods where the Equal Weight Index outperforms.
(Source: https://www.spglobal.com/spdji/en/documents/performance-reports/dashboard-us-equal-weight-sector.pdf)
If we look at the chart above, you could notice the following time periods where the Equal Weight Index outperforms.
Dot Com Crash in 2000
Global Financial Crisis in 2009
Amidst the COVID chaos in 2020/21
Somehow, the Equal Weight Index tends to do better during times of recessions (although its arguable during the COVID crisis as the S&P 500 actually has a lesser drawdown during the initial period). In fact, the Equal Weight Index almost continuously outperformed the S&P 500 every year from 2000 to 2007. That is quite a long period of time for most investors.
Before you start going off investing in the Equal Weight Index right away, hold your horses.
If we look at the performance of the Equal Weight Index compared to the S&P 500 in the past 10 years, here are the results.
In the past 10 years, the S&P 500 index has a CAGR of around 13% while the Equal Weight Index has a CAGR of around 10%. This is a rather big difference.
So while the Equal Weight Index dominated in the 2000s, the S&P 500 Index has had the better performance in the past 10 years.
Personally, I will not invest in an Equal Weight Index though. Here are a couple of the reasons.
Firstly, I don't think there is a way to invest in an S&P 500 Equal Weight ETF without incurring too much of a fee. For an Equal Weight ETF, there is a constant need to rebalance the 500 stocks at an equal weightage and that involves a lot of trading which means fees.
Secondly, I believe that a Market Cap-Weighted Index is market-efficient. Those companies which do well move up in the index in terms of market cap, and contribute more to the gains. Those which do not do so well fall behind and contribute less to the gains. It's rather optimized in my own opinion.
If I want to increase my exposure to the smaller caps, I could probably allocate a smaller percentage of my portfolio to the Russell 2000 index to reap the benefits while maintaining my current investments in the Market Cap-Weighted Index.
Of course, you might have a different opinion.
You are welcomed to join my Telegram channel and take part in the polls to express your stance.
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