How have the S&P 500 Equal Weight Index's exposures influenced its performance over time and why could that matter in the current climate? S&P DJI’s Anu Ganti and Invesco’s Nick Kalivas explore the growing ecosystem and key performance drivers of the S&P 500 Equal Weight Index.
[TRANSCRIPT]
How have the S&P 500 Equal Weight Index’s exposures informed its relative performance?
Anu Ganti:
So over the past decade, we've seen that the S&P 500 has outperformed the S&P 500 Equal Weight Index, and there's two key drivers for this. One is the outperformance of mega caps as equal weight has a small-cap bias by design. The other is the outperformance of momentum, and equal weight has an anti-momentum bias because of the natural rebalancing of selling the winners and buying the losers.
So as a result of this, we've seen that The 500 has outperformed over the past decade. But over the long term, we've seen that equal weight has outperformed not just the S&P 500, but also mid caps and small caps. And an important point is that over time, after peaks in market concentration, we've seen that equal weight has tended to outperform, which is so timely given the current market environment right now.
So these trends in concentration and momentum, they tend to mean revert over time. Of course, it's very difficult to predict in advance when that inflection point will occur, but of course we can look to history as a guide.
Why are the S&P 500 EWI’s factor and sector exposures important in the current climate?
Anu Ganti:
In this climate, understanding equal weight's factor exposures is key, is top of mind. So as mentioned, equal weight has a small-cap tilt. It also has an anti-momentum bias. As a result, equal weight also has a tilt toward value. And finally, equal weight has a dividend tilt, which is especially timely given the current defensive sentiment that we're seeing in the market right now.
Now switching gears, equal weight has different sector exposures versus The 500. So for example, currently equal weight has an underweight to Communication Services and Information Technology. It also has an overweight to Industrials, Real Estate and Utilities. Again, relevant right now in today's environment when thinking about defensive exposure. So very important to understand the distinctions between equal weight and The 500 from a factor lens as well as a sector lens.
How does the S&P 500 Equal Weight Index work in today’s markets?
Nick Kalivas:
Well, for one, given what we're seeing with the big concentration that's present, we think that equal weight can make for a better core of the portfolio and actually manage some of the risks that are present in the cap-weighted S&P 500.
So, for example, right now historically the top 10 names are about 36% of the S&P 500 cap weight. If you go back in history, you haven't seen this type of exposure since the 1960s. The tech bubble, we saw 25%. And if you go to the lower end of the range that we've seen, in the last 20, 30 years, it's about 17.5%. So you have a lot of concentration. And the implications of this concentration are a couple fold.
One, the cap-weighted S&P 500 has a bit of a growth bias. So if you look at its overlap relative to some very popular growth funds, you'll see that overlap is approaching 50%. Now there's nothing wrong with growth, but if you want the core of your portfolio, you might want to be more balanced or diversified. So that's one thing.
The second dynamic that's present is we've seen a lot of valuation stretch in the cap-weight S&P 500 relative to equal weight. So equal weight is relatively inexpensive. The discount right now is about 25% if you look at P/E ratio. Over time, that number is more close to parity. So value-oriented investors might be attracted to equal weight.
On top of that, the cap-weight S&P 500 has actually become more risky than the equal weight, which is very unusual. In fact, if you look at 30-day historical volatility, the cap-weight S&P 500 is about 4% higher than equal weight right now. Going over long history, it's typically the opposite. Equal weight has tended to be 1% more because of its value, small-size tilt. So investors can kind of mitigate some risks that are present with the Mag 7 and the impact on the cap-weighted S&P 500. And then lastly, going back to what Anu said, there may be a good chance for some mean reversion in return given the dominance of the big, growthy names in the market over the last few years.
Could you talk about the growth of the S&P 500 Equal Weight Index ecosystem and the potential implications for investors?
Nick Kalivas:
The ecosystem has really expanded quite a bit. RSP, the AUM in that right now is about USD 75 billion. There are asset owners kind of across the spectrum. We have big institutions, we have financial advisors, we have fast money types that are in there, there's a lot of model usage there, and that has really caused the strategy of equal weight to become more popular.
Now, as a kind of an implication of that, you have futures now on equal weight that trade on the CME. You have an expected option launch on equal weight S&P 500 on the Cboe come April, and so you're seeing this kind of growing interest in the equal weight concept. You have ETF, you have futures, you have options, and they all really are able to kind of meld together to create this very liquid ecosystem, which we think is going to attract even more investors and make equal weight more of a benchmark or go-to way to invest in the market.
Closing:
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