In a recent survey, 69.7% of advisors said they were concerned or very concerned about the concentration of the top five names in the S&P 500. 22.5% of advisors were “just a little” concerned, and just 7.7% of advisors said they were not concerned, according to “When Markets Wobble, Cash Remains King: Free Cash Flow Investing.” (Date: August 30, 2022. Sample size: 293 respondents, 37.9% RIAs.)
This is particularly relevant when looking at the S&P 500 Index, which makes up the core equity portion of many portfolios and has become increasingly concentrated over the years.
In the S&P 500, the top five names – Apple Inc, Microsoft Corporation, Amazon.com Inc, Tesla Inc, and Alphabet Inc Class A – make up 20.5% of the index as of August 31. The market cap-weighted index is tilted heavily toward information technology, with the sector amounting to 27.32% of the index.
Many advisors opt to use the Invesco S&P 500® Equal Weight ETF (RSP) as a portfolio’s core equity holding to remove size bias, effectively mitigating concentration risk.
The S&P 500 EWI is designed to be a size-neutral version of the S&P 500. It includes the same constituents as the cap-weighted S&P 500, but each company in the S&P 500 EWI is allocated the same weight – 0.2% – at each quarterly rebalance.
The simple arithmetic of rebalancing connects equally weighted indexes to momentum effects. If the price of a constituent increases by more than the average of its peers, then its weight in the portfolio will increase, and the position will necessarily be trimmed at the next rebalance as the portfolio returns to equal weights, according to S&P Dow Jones Indices.
On the other hand, if a stock falls by more than the average of its peers, its weighting will fall too, and more must be purchased at the next rebalance to return to equal weight. Thus, equal-weight indexes sell relative winners and purchase relative losers at each rebalance.
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