In the first half of 2023, the cap-weighted version of the S&P 500 Information Technology Index beat the S&P 500 by 26% — one of the widest margins on record for a six-month stretch. As advisors and investors know, that outperformance was driven in large part by a small cohort of mega-cap stocks. As a result, some broad indexes now feature significant weights to a small number of tech and communications services stocks.
Translation: Concentration risk is a growing concern in the indexing community.
To that point, NASDAQ recently announced a special rebalance of the cap-weighted version of the NASDAQ-100 Index (NDX) to reduce the dominance of (MSFT), (AAPL), and friends. Fortunately for investors looking for a more diverse approach to this high-flying sector, the (RSPT ) stands at the ready.
RSPT Standing on Its Own Merit
Enthusiasm for cap-weighted tech exchange traded funds is palpable and understandable. However, it’s worth noting that RSPT is no shrinking violet. The Invesco ETF is higher by 22.52% year-to-date. That’s impressive when considering that none of its 66 holdings exceed a weight of 1.69%.
Compare that with the cap-weighted version of the S&P 500 Information Technology Index, where Apple alone commands of 23% of that gauge. That’s one example of concentration risk in the tech sector. The Herfindahl-Hirschman Index indicates that those concerns are warranted.
“"Tech’s current adjusted HHI level of 9.6":https://www.spglobal.com/spdji/en/documents/performance-reports/dashboard-us-sector.pdf is in the 99th percentile of observations, indicating an extreme level of concentration for the sector compared to the long-term average of 4.9,” according to S&P Dow Jones Indices. “When concentration has been relatively high in the past, it has subsequently tended to decline.”
Typically, one way for concentration risk on cap-weighted ETFs to correct is for market values to decline. That’s not guaranteed to happen with tech over the near term. If anything, it’s a risky bet to make. However, that ominous scenario highlights the advantages of RSPT’s diversification benefits.
Something else to ponder regarding RSPT: While history doesn’t always repeat, it often rhymes. That’s potentially good news because RSPT has history on its side.
“The tendency of Tech concentration to reverse has important implications for the performance of equal-weight sector strategies,” added S&P Dow Jones. “Typically, after peaks in concentration (such as during 1990, 1999 and 2002), equal-weighted Tech has outperformed.”
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