Mega Cap ETFs: Is Bigger Always Better?

by on December 15, 2009 | ETFs Mentioned:

At the core of many investor portfolios is an allocation to large cap domestic equities. Because large cap stocks generally have long operating histories, established customer bases, and sufficient cash on hand, they are perceived as the least risky of equity investments, strongly correlated with mid cap and small cap stocks but less volatile than smaller companies. Moreover, because many of these companies are multinational firms that generate revenues from dozens of countries around the world, they provide some degree of international diversification within the equity allocation.

Most ETF investors elect to achieve their exposure to large cap stocks through an S&P 500 ETF, investing in either SPY or IVV (although some prefer alpha-generating alternatives). Composed of the 500 largest U.S.-listed stocks (with a few exceptions), the S&P 500 is considered by many as a reliable indication of broader stocks markets. Because these S&P 500 ETFs are cap-weighted, the bulk of holdings are in the largest companies, while the smaller firms (i.e., companies 300-500) receive small weightings. But some investors may prefer to avoid these lesser-known components altogether, investing only in “mega-cap” companies that have total market capitalizations in excess of $10 billion.

Mega Cap ETF Options

There are a number of potential uses for mega-cap stocks in a portfolio. Some investors may prefer to achieve the majority of their equity exposure through these stocks, avoiding more risky companies altogether. Others may use mega caps as a complement to holdings in small cap (or even micro cap stocks) to form a “barbell” approach to the equity component of their portfolios. ETFdb Pro members can see how these various equity ETFs are used in our line of all-ETF model portfolios (if you’re not a Pro member yet, sign up for a free trial or read more here).

For investors looking to efficiently gain access to mega-cap domestic equities, there are several ETFs that invest in the largest of the large U.S.-listed stocks. In descending order of number of holdings, these funds include:

  • Vanguard Mega Cap 300 ETF (MGC): Based on the MSCI US Large Cap 300 Index, this fund invests in 300 of the largest domestic equities. Led by holdings in Exxon Mobil, Microsoft, and Procter & Gamble, MGC is well diversified across all sectors of the U.S. economy. With an expense ratio of just 0.13%, this ETF is one of the cheapest ways to establish mega cap exposure.

MGC

  • iShares S&P 100 Index Fund (OEF): The index underlying this ETF includes 100 of the largest publicly-traded companies, and has median and total market capitalizations of about $40 billion and $6.2 trillion. By comparison, the S&P 500 has a median market capitalization of about $8 billion. OEF has a beta of 0.92 relative to the S&P 500, indicating that these larger companies are slightly less volatile that the more diversified S&P 500.

OEF

  • Rydex Russell Top 50 ETF (XLG): As its name suggests, this ETF offers cap-weighted exposure to the 50 largest U.S. companies, which in aggregate represent more than 40% of the total market cap of the Russell 3000.

XLG

YTD Performance

ETF YTD Gain
SPY 23.8%
MGC 22.8%
OEF 19.8%
XLG 17.6%

In 2009, the mega cap ETFs highlighted above have delivered solid gains, but lag behind funds linked to the S&P 500 be a decent margin. Year-to-date performance shows a clear inverse relationship with the number of individual holdings maintained by each ETF, indicating that the smaller components of the S&P 500 have outgained mega caps so far this year.

Disclosure: Long IVV.