Key Points
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The S&P 500 has become very concentrated in large tech names benefiting from AI.
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What would happen to the S&P 500 if the AI trade were to struggle?
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The Invesco S&P 500 Equal Weight ETF weights every name in the S&P 500 evenly.
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With the broader benchmark S&P 500 index roughly four years into a bull market, many investors have become increasingly concerned about a looming reset that could lead to a correction or even a bear market.
Furthermore, the S&P 500 is now incredibly concentrated in about a dozen high-flying big tech names that have soared due to their exposure to artificial intelligence (AI). This has raised concerns that the broader market is much less diversified than in the past, and therefore vulnerable.
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Should you forget the Vanguard S&P 500 ETF (NYSEMKT: VOO) and buy the Invesco S&P 500 Equal Weight ETF (NYSEMKT: RSP) instead?
The broader benchmark has become concentrated
Large tech names have seen their market values soar, due to investors increasingly betting that AI will disrupt society as we know it. The S&P 500, which is supposed to reflect the actual makeup of the stock market — and is therefore market-weighted — has also seen AI become a larger part of it. As of this writing, the top eight stocks in the S&P 500 now account for 37.2% of the index:
Nvidia — 7.49%
Apple — 7.16%
Microsoft — 5.65%
Amazon — 4.01%
Alphabet — 5.99%
Meta Platforms — 2.54%
Broadcom — 2.29%
Tesla — 2.07%
With this kind of concentration, if the AI trade falters, there are real concerns about what might happen to the stock market. It’s possible that investors would simply rotate into the non-AI names and things would balance out. But there’s also a real chance that the entire market would struggle.
Many of the names above are spending hundreds of billions on AI-related capital expenditures, and this money is actually finding its way to other S&P 500 companies, powering their earnings. However, as some hyperscalers begin to generate negative free cash flow, they are seeing increasing pressure to either demonstrate the payoff of their AI investments or slow spending.
If they don’t slow spending, they might see their stocks sold off as balance sheets continue to deteriorate. But if they do slow capex, other S&P 500 companies benefiting from that spending might see their earnings power decline, so it’s a tough situation.
The Invesco S&P 500 Equal Weight ETF simply removes the market-weighting component and gives every company in the S&P 500 an equal weighting, so Nvidia’s stock would carry the same importance as any other stock in the S&P 500.
Should you forget VOO and buy RSP?
An easy first step in evaluating whether to sell VOO and buy RSP is to look at average annual returns over a variety of time periods, as of Sept. 30:
| Time Period |
S&P 500 |
S&P 500 Equal Weight |
| Year to Date |
12.75% |
10.03% |
| 1 Year |
15.74% |
11.56% |
| 3 Years |
22.89% |
15.73% |
| 5 Years |
13.79% |
8.78% |
| 10 Years |
15.33% |
11.66% |
| Inception (April 2003) |
11.59% |
11.53% |
Data source: Invesco.
As you can see in the chart, the broader benchmark S&P 500 has outperformed the equal-weighted S&P 500 index in every comparable listed period. However, RSP has not performed badly. Over the last three years, the concentration and outperformance of large AI names have led to the broader benchmark’s greatest dominance over the equal-weighted index.
But since the equal-weighted index’s inception in 2003, the two have performed similarly. Additionally, according to S&P Global, the equal-weighted index outperformed the market-weighted S&P 500 index on total returns since its inception. This also holds true when the equal-weighted index was backtested to the 1970s.
Part of the reason is that the equal-weighted index has greater exposure to smaller companies that might grow faster or are value plays. Smaller names have contributed over half of the equal-weighted index’s outperformance, according to S&P Global.
In recent years, the largest names have grown revenue and profits incredibly quickly. They have also served as a flight-to-safety at times, which is why they have outperformed most other names in the S&P 500.
So, should you sell the broader market and purchase the equal-weighted S&P 500? It’s a tough decision because if the market-weighted S&P 500 remains heavily concentrated and AI continues to work, the equal-weighted index will likely underperform.
However, if concentration declines, then the equal-weighted index should benefit. The equal-weighted index also has a history of outperformance on a total basis.
Ultimately, I think it comes down to preference. Long-term investors can succeed by investing in either. But if you are worried about concentration and don’t think it will last, allocating some funds to the equal-weighted index rather than the S&P 500 makes sense right now.
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Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Broadcom, Meta Platforms, Microsoft, Nvidia, S&P Global, Tesla, and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
