The S&P 500 Equal Weight index has outperformed the standard market-cap weighted version over the long term.1
The S&P 500 index has seen concentration in the largest stocks rise to record highs and valuations stretched, driven by the Magnificent Seven.
History shows that markets often revert to the mean, which could present an opportunity for investors looking to gain diversified exposure to US equities.
The equal weight version of the S&P 500 index outperformed the standard, market-cap weighted index by an average of 1.05% annually, until 2023i. Since then, however, the S&P 500 Equal Weight Index has underperformed, as the returns of the Magnificent Seven (“Mag7”) stocks have overshadowed the rest of the index. Many of today’s investors may wish to consider gaining exposure to the S&P 500 Equal Weight index because of three factors: high concentration, stretched valuations and mean reversion of excess returns.
At the end of Q3 2024, 35% of the weight in the S&P 500 was in just 10 companies, and this handful of companies contributed to over half the S&P 500’s volatility (see Fig.1). This is the highest concentration level in the S&P 500 since the late ‘70s, and many of these highly volatile names sit in similar industries, leading to higher pairwise correlation in the top 10 names than the broader index. This further exacerbates the S&P 500’s concentration problem.
Market-cap weighting naturally underweights the future disruptors. The current top 10 represented a mere 3% of the S&P 500 index 20 years ago. Over these two decades, the top 10 names have contributed 23% to the index’s return, but this rose to over 70% in the first half of 2024ii. Market breadth normalised in Q3, so will this trend of mean reversion continue?
High valuations in mega caps have pushed the S&P 500’s P/E ratio to 28.0 (see Fig.2), a 28% premium over S&P 500 Equal Weight. Historically, over the past 20 years, equal weight and cap-weighted S&P 500 indices have had similar P/E ratios. The divergence widened during COVID as the shift to working from home benefited many technology names. The excitement surrounding AI propelled the S&P 500’s valuations even further.
The anticipation of high growth across select companies often drives rising valuations and increased market concentration, as has been witnessed recently. Historically, over the past 30 years, it has been challenging for these “superstar” companies to sustain exceptional growth over extended periods. Over time, these companies often revert towards normalcy, leading to market valuations and concentration mean-reverting. For example, over the past 30 years, only 3% of companies stayed in the top quintile for sales growth for three consecutive years (see Fig.3).
An equal weighted approach may help mitigate some of the valuation risk present in the S&P 500 and its current tilt towards growth. This mitigation may provide less sensitivity to lowered growth expectations.
The S&P 500 Equal Weight index is currently recovering from its worst 12-month relative drawdown in the past 20 years (see Fig.4), driven by historically narrow market performance. In Q3 2024, market breadth expanded and reverted to median levels, benefiting diversified strategies like equal weight.
Historically, high market concentration in the S&P 500 has often been followed by increased market breadth, which over longer time periods has often benefited the S&P 500 Equal Weight’s performance relative to the S&P 500 index.
During 2021, the Mag7 led performance, returning 51.5% v the S&P 500’s 28.7%, but it peaked towards the end of that year and mean-reverted in 2022. During this time of mean-reversion, Equal Weight outperformed the Mag7 by 34%. This story began again in 2023, with the Mag7 driving 61% of the market’s return through June 2024iii. In Q3 2024, the market scrutinised AI’s valuations and the timeline for realising their earnings expectations plus the Fed’s rate cuts led to market breadth expansion and the other 493 names in the S&P 500 outperforming the Mag7iv.
With the S&P 500’s market concentration near multi-decade highs along with stretched valuations, the need for diversification continues to resonate and many investors are turning to equal weight to diversify their portfolio.
This UCITS ETF offers an alternative weighting methodology to the S&P 500 index, providing exposure to the same companies as the standard index but equally weighting each one at each quarterly rebalance.
An investment in this fund is an acquisition of units in a passively managed, index-tracking fund rather than in the underlying assets owned by the fund.
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1 Source: Bloomberg, annualised return between 1989 and 2023
i Source: FactSet, 30 April 1999 to 31 December 2022
ii Source: FactSet, analysing the weight in the top 10 companies of the S&P 500 from 30 April 1999 to 30 September 2024. Return attribution is isolating the average annualised company return of the largest 10 companies by market cap in the S&P 500 monthly over the past 20 years and over the past year versus the average company in the index.
iii Source: FactSet, 1 January 2023 to 30 June 2024
iv Source: Bloomberg. S&P 500 companies excluding Mag7 returned 9.6% v Mag7 companies 5.4%
10 year performance table
Performance of indices (%) |
Oct '23 - |
Oct '22 - |
Oct '21 - |
Oct '20 - |
Oct '19 - |
Oct '18 - |
Oct '17 - |
Oct '16 - |
Oct '15 - |
Oct '14 - |
Dec '23 - |
Dec '22 - |
Dec '20 - |
S&P 500 Net Total Return |
37.42% |
9.59% |
-15.01% |
42.29% |
9.09% |
13.63% |
6.73% |
22.87% |
3.83% |
4.55% |
21.70% |
25.67% |
31.24% |
S&P 500 Equal Weight Net Total Return |
31.35% |
-1.32% |
-10.35% |
48.51% |
-0.06% |
12.13% |
3.99% |
19.72% |
5.04% |
2.24% |
14.67% |
13.17% |
28.53% |
Returns may increase or decrease as a result of currency fluctuations. Source: Bloomberg, Invesco, Performance as a 31 Oct 2024. Past performance does not predict future returns.
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Data as at 30 September 2024 unless otherwise stated.
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