As we mentioned, the S&P 500 index funds have been the preferred choice of investors who do not want to directly choose a single stock. In particular, these funds have looked quite good in the past few years thanks to the unprecedented growth of Big Tech. However, the market of the U. S in the particular context of the stock and various other related derivatives has already attained the apex of concentration in a few big players, which poses a risk to the investors.
By the end of the day August 30th, the SPDR S&P 500 ETF Trust which is a $566bn fund that tracks the S&P 500 had 19. 6% of its portfolio concentrated in just three stocks: Apple Inc. , Microsoft Corporation and Nvidia Corporation these companies have performed extremely well but there is too much focus on the companies hence the degree of diversification that is normal for most index investors is completely gone. A decade ago, the top three holdings of this ETFL had an exposure of only 7 percent. Social responsibility investment made up 9% of its portfolio, as presented in the semi-annual report for June 30, 2014.
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Historical S&P 500 Returns: Innovation of A Perspective
According to data, S&P has been gaining around 15 percent a year on average in the last five years with the dividend reinvestment. 9%, according to FactSet. But to put this in perspective, the average annual return over 20 years is 9 percent. 8% and the 30-year average of this type of award is 10.7%. This should indicate to you that, despite the last year being great, the long run is slightly better.
How Current S&P 500 Market Concentration Relate to the Historical Numbers?
Nastou explained in a report that: “In the history of the contemporary United States, this is one of the most concentrated eras in history. MFS, with a total of $628bn in assets under management, assessed five waves of concentration, the highest in 1932, 1957, 1973, and 2000, and the current cycle.
The research also found out that, these concentration spikes tend to last for about 10 minutes. 3 years. The contract was patterned after each peak and followed by a 10. This period of diversification normally takes approximately 7 years after giving a consistent flow of specialization increase. This trend of market concentration has remained going for almost 1. 8 years more than the market average period.
What Are The After Effects When Concentration Reaches Its Apex?
Other authors of the report, including Beane said that although it was very hard to determine when the current concentration cycle would be done, history has it that at some point markets are bound to reach the tipping point. After that periods of diversification are usually seen coming out; preferred with other types of investment strategies. For instance, index funds that invest an equal amount in all constituents, and small-cap value strategies generally have better performance at such a time.
The author of the research work MFS found out that in a year after concentration peaks, an equal-weight index of the U S stocks earns 8% more average annualized returns than a cap-weighted index in the next 10 years.
Why Invest in an Index Fund That Targets Equal Weights for All Stocks?
While accounting for the S&P 500 index fund has proved to be rewarding, the addition of an equal-weighted fund to your portfolio may assist in curing risk and probably improve the compound rates of return in the long run. To give an example of such an investment, one could name the Invesco Equal-Weight S&P 500 Index Fund which has $61. 9 billion in assets. To maintain equal investments in all the S&P 500 companies, it rebalances its positions quarterly. Although the cap-weighted US-based SPDR S&P 500 ETF (SPY) fund has outperformed other indices in the prior decade, the equal-weighted approach has proven to be more robust in other time horizons.
To date in 2024, Invesco has seen $6bn of net inflows into the Invesco Equal-Weight S&P 500 Fund as investors worry about massive concentration risks.
Here are a few comparisons between SPY and Invesco’s equal-weighted index fund: Here are a few comparisons between SPY and Invesco’s equal-weighted index fund:
Thus, it can be stated that during the period from August 2014 to August 2024, the chosen stock market tracker – SPY – was more effective in comparison with the equal-weighted fund.
- This efficient outperformance shows that like in the Previous 10-Year Period ending August 2014, the equal-weighted fund trounced SPY.
- Within 20 years, therefore, SPY performed better but a significant part of the said outperformance was realized within the most recent years.
- Valuation Comparison: Index funds for S&P 500 Vs. Equal-Weighted Funds
- Specifically, for the American market, it is now at 21 based on the forward P/E ratio, estimated at Friday’s close. 4, yet, this is way above the ten-year moving average of 18. Somewhat differently, Invesco’s fund investing in large-cap stocks is still an equal-weighted fund with a much cheaper forward P/E ratio of 16. At $74. 31, it is at par with the firm’s average yearly operating profit for the past decade. This discrepancy could mean that an equal-weighted fund is more compelling from a valuation perspective at present levels.
Small-Cap Value: A second pattern for post-concentration markets. Another Strategy for Post- Post-Concentration Markets
Another approach that was also described by Beane is the small-cap value funds, and these funds are usually good when market concentration is not the case. For instance, one is the MFS Blended Research Small Cap Equity Fund which is abbreviated as BRSJX, while the second one is Invesco S&P SmallCap Value with Momentum ETF. These funds let the investors make an investment point in small companies that usually reap benefits when the concentration is shifted from large-cap stocks.
Conclusion:
Several factors will help to determine whether is it time to diversify or not, these include:
As for when all this is going to end, nobody can predict, but it is necessary to be more careful when the S&P 500 concentration cycle is at its peak. You will have more diversified risks by using equal-weighted funds or small-cap value ramps so that you’ll better hedge your bet. And as Beane rightly has to say “diversification is more important than getting the timing right. ”
