The stock market is facing significant risks in 2023, primarily due to increasing concentration among a handful of companies within major indices, particularly the S&P 500. This trend toward concentration raises concerns for investors about the potential for a market downturn if the performance of those top companies falters. In this landscape, finding alternative strategies to hedge against these risks is crucial. Two promising index funds, the Invesco S&P 500 Revenue ETF (RWL) and the Invesco S&P 500 Equal Weight Technology ETF (RSPT), emerge as strong contenders for investors looking for a more balanced and less risky investment approach.
Concentration Risk in the S&P 500
The S&P 500 is more concentrated than ever; the top 10 stocks now account for approximately 40% of its total market capitalization. This unprecedented level of concentration raises worries among analysts and investors, particularly in a volatile market. As David Kostin, Chief U.S. Equity Strategist at Goldman Sachs, points out, this high concentration could lead to significantly lower returns for the S&P 500 over the coming decade compared to what historical patterns would suggest.
This makes the performance of industry leaders critical. A downturn for these dominant firms can have a ripple effect; poor earnings reports or market corrections of just a few major companies can disproportionately affect the entire index, resulting in substantial losses for investors.
The Invesco S&P 500 Revenue ETF (RWL)
Overview
The Invesco S&P 500 Revenue ETF takes a unique approach by weighting its holdings based on their trailing 12-month revenue rather than market capitalization. This methodology sets it apart because it aims to minimize the impact of the largest firms on the ETF’s overall performance.
Performance and Benefits
- Diversified Exposure: The ETF manages to distribute risk more evenly among its constituents. Its 5% cap on individual stock weightings helps mitigate concentration risk, ensuring that no single company’s underperformance can dramatically affect the overall fund.
- Historical Resilience: During the bear market in 2022, RWL declined by 18%, which, while substantial, was less than the S&P 500’s 25% fall. This resilience highlights the fund’s strategy in volatile markets.
- Long-Term Growth Potential: While the Invesco ETF returned 245% over the last decade, it did underperform the traditional S&P 500’s 310% gain. This serves as a reminder that while avoiding concentration risks can provide stability, it may also come at the cost of missing out on the significant upside enjoyed by leading firms.
Costs
The expense ratio is relatively high at 0.39%, which translates to $39 annually on a $10,000 investment. Although above the average for U.S. ETFs, the fund can still be a worthwhile investment for those looking for broader exposure without the heavy concentration risk.
The Invesco S&P 500 Equal Weight Technology ETF (RSPT)
Overview
This ETF focuses exclusively on technology stocks—currently one of the best-performing sectors in the market. As the name implies, the Invesco S&P 500 Equal Weight Technology ETF assigns equal weight to each of its 68 constituents, eliminating the concentration impact typical of market-cap weighted funds.
Key Advantages
- Performance: Over the past decade, the fund has delivered a total return of 468%, outperforming the S&P 500 significantly. This performance can largely be attributed to the booming technology sector.
- Future Growth: Analysts believe the technology sector will continue to thrive, with the potential for artificial intelligence to drive the market significantly in the coming years. Hedge fund manager Philippe Laffont predicts that technology could represent 75% of the entire U.S. market cap by 2030.
- Equal Weighting Benefits: By distributing performance impact evenly across all holdings, the fund minimizes risks associated with reliance on a few dominant players.
Costs
Similar to the RWL, the RSPT has an expense ratio of 0.40%, resulting in an annual charge of $40 per $10,000 invested. While not the lowest, many investors are willing to pay this for the potential protection and performance benefits offered.
Conclusion
As concentration risks mount in the stock market, investors find themselves in a challenging environment. The significant weighting of a few large companies in the S&P 500 makes it susceptible to volatility. Therefore, having a diversified approach through index funds like the Invesco S&P 500 Revenue ETF and the Invesco S&P 500 Equal Weight Technology ETF can be a wise strategy for hedging against concentration risk.
Both funds offer investors alternative ways to capture market gains while minimizing risks associated with over-reliance on a select number of dominant firms. While RWL focuses on broader S&P 500 exposure through revenue-based weighting, RSPT taps into the dynamic technology sector with an equal-weight strategy.
While these ETFs may not provide the explosive growth potential of the top-performing stocks in the S&P 500, they represent a balanced approach to investing in a precarious market. Ultimately, thoughtful allocation and portfolio diversification remain essential for navigating the complexities of today’s investing climate.
