Deconstructing the Composition of the S&P 500 Index
The Standard and Poor’s 500 Index, most commonly known as the S&P 500, is one of the most popular equity market indices in the world and often used to gauge the performance of the overall stock market in the United States. However, although the index tracks roughly 500 public companies, its current high level of concentration across a handful of names has become scrutinized in recent times. We look at the current and historical composition of the S&P 500 to understand how diversified the index really is.
To begin, the S&P 500 is a market-cap weighted index where the largest underlying companies by market capitalization (calculated as number of outstanding stock shares x current market price per share) have a higher allocation than those companies with smaller market capitalizations. As a result, and due to the sizeable market-cap discrepancies between the largest and smallest companies, the top 10 names within the index account for about one third of the entire index1. This is the highest level of concentration in the top 10 companies over the last 30 years, surpassing the peak experienced during the dot-com bubble. For comparison, the top 10 companies within the MSCI EAFE Index (an international developed markets index) account for 15.4%, a level below its peak in the early 2000s.
In addition, not only are we experiencing a concentration to a handful of names within the index, but we are also experiencing concentration from an equity style lens. Generally, stocks are characterized as either Growth or Value stocks. Value stocks, compared to Growth stocks, generally have low price-to-book ratios, low price-to-earnings ratios, and/or high dividend yields. Historically, the distribution of Growth and Value names within the S&P 500 classified the overall index as Blend – no large allocation to either Growth or Value stocks. Now, with the current level of concentration, the composition of the Index has moved from its Blend characterization to Growth for the first time since its inception.
Source: Morningstar data from September 30, 2000 through June 30, 2024. Morningstar’s Raw Value-Growth Score classifies individual stocks as value, core or growth. Morningstar will also assign Raw Value-Growth scores to a portfolio each time it discloses holdings, based on the asset-weighted average of underlying stock scores in the portfolio. A portfolio raw score less than 125 is considered value, greater than 175 is considered growth, and in between is considered blend.
What does this all mean?
An investor must understand that allocating to exchange-traded funds or mutual funds that track the S&P 500 Index (you cannot invest directly in an index) may not be as diversified as they might expect and is certainly not as diversified from stock and style exposures relative to the recent past.
How can you increase your equity diversification from the S&P 500 Index?
As noted, the S&P 500 Index is a market-cap weighted index tracking the largest 500 U.S. stocks. Diversification from this index can be increased by allocating to non-U.S. stocks, mid and small-cap U.S. stocks, value-style stocks, and/or equal-weighted index ETFs or mutual funds (equal-weighted indexes do not allocate based on market capitalization size, rather they equally weight stock exposures regardless of size).
What are some potential benefits (and perhaps risks) in owning a diversified portfolio as opposed to an overly concentrated one?
In overly concentrated portfolios, the overall performance of your investments is highly correlated to the performance of a few names. For example, seven stocks were responsible for over 50% of the S&P 500’s entire performance in 2023. While this concentration helped in 2023, no one can say how long this trend can persist. History tells us however that equity markets are constantly evolving, and this concept also applies to the performance and relative size of individual companies. The illustration below ranks the top three companies by market capitalization size at the end of each calendar year dating back to 1950.
One takeaway from the illustration above is that while some companies may rank highly for extended periods of time, they have eventually been dethroned.
Additionally, diversified portfolios may experience lower levels of volatility than those experienced in highly concentrated portfolios. This means that the value of investments in diversified portfolios will fluctuate to a lesser degree than those in highly concentrated positions. The following illustration depicts how the market-cap weighted S&P 500 Index experienced a greater drawdown from its most recent high over the last year than its equal-weight counterpart.
In conclusion, the current level of concentration within the S&P 500 Index is higher than what investors have experienced over the last few decades and its current composition may prove to be an inadequate or unfair comparison to fully diversified equity portfolios. Diversified portfolios may also come into favor over highly concentrated ones when we experience a shift, rotation, or broadening of the equity markets as we saw in the third quarter of this year. Last quarter we saw the equal-weight S&P 500 Index outperform the market-cap weight S&P 500 and a basket of 7 stocks often referred to as the Magnificent Seven.
Sincerely,
Portfolio Manager
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Disclosure:
The views expressed represent the opinions of Wolf Group Capital Advisors as of the date noted and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. The information contained has been compiled from sources deemed reliable, yet accuracy is not guaranteed.
Diversification and asset allocation do not ensure a profit or guarantee against loss.
The information presented is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third-party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment, tax or legal advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and is subject to change without notice.
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- The top 10 stocks within the SPY ETF as of 10/21/2024 account for 34.7% of its total weighting.