The high-flying S&P 500 stock index has a massive diversification problem, but it’s now easily fixable.
Seven tech stocks make up nearly 30 per cent of the S&P 500 – Apple Inc., Microsoft Corp., NVIDIA Corp., Amazon.com Inc., Alphabet Inc., Tesla Inc. and Meta Platforms Inc. It’s all good right now because these seven stocks have helped to power big returns for the S&P 500 in recent years.
But there’s a growing sense that this trend cannot last and will end badly. What’s an index investor to do? A fresh answer to this question can be found in an exchange-traded fund called the iShares S&P 500 3% Capped Index ETF (XUSC-T). This TSX-listed ETF caps all the stocks in the S&P 500 at 3 per cent, which compares to 7 per cent for Apple and Microsoft in the regular version of the index, 6.5 per cent for NVIDIA, 3.7 per cent for Amazon and 2.3 per cent for Alphabet and Meta.
XUSC launched on July 9, so it’s too new to have any published data on its performance or management expense ratio. The management fee is posted at 0.12 per cent, which suggests a still-reasonable MER of a few ticks higher.
Another possibility if you’re concerned about S&P 500 over-concentration is a fund like the Invesco S&P 500 Equal Weight Index ETF – CAD (EQL-T), with each of its holdings weighted around 0.2 per cent. Think of XUSC as a middle ground between equal weight and traditional indexing, where stocks are weighted according to their market capitalization. That means shares outstanding multiplied by share price.
A reader recently got in touch to ask if it makes sense from a diversification perspective to shift some money held in a traditional S&P 500 index ETF into an equal-weight version. The answer is that a partial change seems better than making a full-on move out of the traditional S&P 500. The seven tech stocks leading the S&P will eventually lose momentum, but it may take a while.
If you’re a long-term investor with exposure to the S&P 500 index, there’s a case to be made for letting the index be the only index and doing nothing. Yes, you’ll have to give up some of the amazing gains of the past couple of years at some point if you continue to hold a traditional S&P 500 index ETF. But long-term data consistently shows that the S&P 500, imperfect as may be at times, is hard to beat if you buy and hold.