Is Your Broad Market Index ETF Suffering from Tech Bloat? by Steve Abramowitz

You don’t need Eli Lilly’s Ozempic to slim down. If you want to lose some of that tech bloating in your S&P 500 or total market index fund, I’ve got just the medicine to reduce the overweight.

Several sponsors offer ETFs that cut your exposure to possibly overvalued large technology stocks by weighting each company in the sector equally rather than by size. This strategy greatly reduces the impact of the largest companies in the fund, including the Magnificent 7 and other stocks propelled by the artificial intelligence mania.

Correspondingly, the minimization of those mammoth growth stocks increases the influence of possibly overlooked value and smaller stocks, vastly improving your diversification. We’ll review the two most popular equally weighted ETFs here, with an eye toward informing readers open to this kind of repositioning.

Invesco S&P 500 Equal Weight ETF (symbol: RSP)

 If this name sounds vaguely familiar, that’s because it is. The fund simply takes 500 of our largest and strongest companies and weights them equally. Although classified by Morningstar as a large blend fund, RSP actually has a value and smaller stock tilt. In fact, it contains twice as many value and four times as many smaller stocks than the standard Vanguard S&P 500 ETF (symbol: VOO).

The equally weighted S&P yields slightly more than the conventional index (1.6% vs. 1.3%) and costs more (.20 vs. .03). The higher turnover (21% vs. 2%) needed to periodically return the holdings to equal weight status increases expenses. Like its larger counterpart, the Invesco ETF’s high volume virtually eliminates any spread.

Clearly, in many respects RSP is a less efficient fund than VOO. But it has several meaningful advantages. The reduction in size and sector in the equal weight portfolio is dramatic, with the more balanced alternative having a market capitalization only one-fifth that of the S&P. Assets in the top ten holdings crater from 34% to 2% and the technology stake drops from 32% to 15%. Similarly, eight of those ten in the Vanguard S&P 500 are tech companies, whereas none appear in the equal weight option.

The question of volatility is not so easily resolved. In the twenty years ending in mid-2023, shares of RSP were about 12% jumpier than they were for VOO. But this relationship has recently reversed, presumably because of the overrepresentation of the fast-paced technology names in the S&P.

The heavier technology position in VOO likewise affects the relative performance of the two funds. In the technology debacle of 2022, the S&P lost 18% as against only 12% for the equal weight ETF. But in last year’s tech rally, the standard S&P outgained its less concentrated counterpart by 12 percentage points. Through August of this year, Vanguard’s S&P 500 has bested Invesco’s equal weight fund by a notable margin (19% vs. 12%), again implicating the differences in sector and style allocation.

Direxion Nasdaq 100 Equal Weight ETF (symbol: QQQE)

 This boutique fund is suggested only for the most venturesome of readers. It is categorized as large growth because its technology position (40%) is almost as high (49%) as it is for Vanguard’s Growth ETF (symbol: VUG). Consequently, the ride is only slightly less bumpy than it is for VUG.

The equally weighted Nasdaq ETF must be considered nondiversified even though the technology stocks comprising it are much smaller and less focused than those in the Vanguard Growth fund. The top ten stocks in the portfolio only account for 12% of assets and none of the massive artificial intelligence beneficiaries. Volume is moderate but the spread is acceptable. However, its yield is low (0.9%), it’s costly (.35) and its turnover is high (30%).

Just as with the equally weighted S&P ETF, comparative performance for the Nasdaq fund depends on the success of the tech behemoths. Thus, when large technology stocks were pummeled in 2022, the equally weighted version of the Nasdaq 100 declined less (-24%) than Vanguard’s growth offering (-33%)

Not surprisingly given the steep gains in the very large technology stocks last year, the equally weighted Direxion ETF trailed Vanguard Growth by 13%. Continuation of those stocks’ outperformance through the first eight months of this year resulted in another marked advantage for the tech-infused growth ETF, which gained 21% as against 6% for the less concentrated Direxion ETF.

Takeaways

The two equally weighted ETFs could play very different roles in a retirement portfolio. The Invesco S&P 500 Equal Weight ETF could be helpful at the critical sequence of returns juncture just before or early in the withdrawal phase. Say your core holding is Vanguard’s S&P 500 ETF or its Total Market ETF, meaning that about one-third of your retirement nest egg is in the technology basket.

Is that really where you want your life savings to be? Is it worth staying with the standard S&P should the technology behemoths enter a sharp correction that could wreak havoc on your withdrawal formula and limit your ability to participate fully in a recovery? It might well be more sensible to enhance your diversification by spreading your risk over possibly less overvalued smaller technology companies as well as democratizing the entire S&P.

By contrast, the tech-heavy and fast-paced Nasdaq ETF from Direxion is verboten for most of us during retirement. However, I believe it can be deployed effectively to serve a particular purpose for a young and aggressive investor still early in the accumulation phase. He might want to maximize appreciation by overweighting the technology sector, but in a more diversified way than simply concentrating on a few skyscrapers that may be vulnerable to a sharp correction.