Persistent fears over market concentration have led many investors to grow wary of sticking with the mega-cap growth trade that carried the major averages higher throughout much of 2024. The top five stocks in the S&P 500 alone account for 25% of the benchmark index’s weighting, while the top 10 stocks have made up more than a third of the benchmark. That’s the highest level of concentration the S&P has experienced in decades.
Right now, the S&P 500 is trading at over 25 times forward earnings. But if you strip out the top 10 stocks, that multiple is hovering closer to 19 times forward earnings. Historically, smaller-cap stocks have exhibited more volatility than larger-cap companies. But that hasn’t been the case this year. The largest stocks have contributed a record 70% of the market’s overall volatility just in the last few months. Meaning, investors have had to pay a price for those higher returns.
Traditional market-cap-weighted ETFs are often heavily influenced by the largest companies. Equal-weight ETFs mitigate this risk by spreading investment more evenly across all companies in the index. Small- and midcap companies tend to perform well under lower rates and steady growth environment. This is the very setup we’re seeing as we head into the fourth quarter. By providing more balanced exposure across varying sectors and market caps, equal-weight ETFs can also help investors achieve diversification and potentially enhance the risk/reward profile of a more well-rounded portfolio through strategic rebalancing.
At present, the earnings growth differential between mega-cap growth and the median stock in the S&P 500 is extremely wide. But it has come down from prior years. Goldman Sachs expects that gulf to continue to narrow heading into 2025 and beyond.
Additionally, the S&P 500 Equal-Weight index outperformed cap-weighted returns in 10 of the 20 years between 2003 and 2023. And cumulative returns for the 20-year period are about the same across the two indexes, per research from State Street Global Advisors.
Equal-Weight ETFs on the Rise
With investors craving diversification, a handful of equal-weight ETFs have risen to new heights for the year.
The Invesco S&P 500 Equal Weight ETF (RSP) just notched a new 52-week high, up 11%. The $61 billion fund takes a broad-based approach, holding all 505 S&P stocks. This has allocated dollar amounts equally across sectors and effectively underweighting tech as a result. RSP has enjoyed great success this year, with a haul of roughly $6 billion. The fund charges an expense ratio of 0.20%.
The actively managed Astoria U.S. Equal Weight Quality Kings ETF (ROE) is the best-performing among its peers — up more than 17% — also seeing net inflows for the year. ROE is designed to mirror the sector exposure of the S&P. It takes a more focused, targeted approach with only 100 holdings. The ETF was constructed based on differing combinations of quality metrics that vary by sector. This makes it a viable supplement to a core indexed strategy.
The ALPS Equal Sector Weight ETF (EQL) provides yet another avenue for equal-weight exposure. But it takes an equal-weighted approach across all 11 Select Sector SPDRs. This results in a drastically different composition relative to cap-weighted funds like the SPDR S&P 500 Trust (SPY). The fund is up 14% for the year. It rebalances quarterly and has an expense ratio of 0.25%.
The iShares MSCI USA Equal Weighted ETF (EUSA) takes another slightly different approach. It focuses more on large- and midcap companies. The fund was devised to offer investors more exposure to midcap stocks and reduce biases toward the largest U.S. stocks. Among the cheapest products of its kind, EUSA boasts a low expense ratio of just 0.09%. The fund is also up 11% for the year and has seen nearly $1 billion in net inflows.
As the financial landscape continues to shift, equal-weight ETFs stand out as valuable tools for investors looking to mitigate risk and capitalize on the growth potential of smaller and midcap stocks. Whether driven by a desire for diversification or simply a strategic response to market conditions, the rise of equal-weight ETFs underscores a broader trend toward more nuanced and balanced investment strategies as a whole.
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