4 new positions for the Blend Portfolio
1 ETF & 3 stocks
Hello Antagonist members,
It’s the 3rd Sunday of the month, which is when I announce new positions for our Blend Portfolio. Today, I’m adding one ETF and three stocks.
Background for recommendation #1
My ETF recommendation flows from the articles I’ve recently written about the S&P 500. I’ve argued that since the S&P is a market-capitalization weighted index, it presents a distorted view of the market.
The combined weighting of just 2 companies—Apple (AAPL) and Microsoft (MSFT)—now accounts for more than 13% of the S&P 500 index. That’s an all-time high.
The entire market is now virtually made up of 9 stocks. Without those 9, the S&P 500’s gains in the first quarter would have been negative. Additionally, just 3 companies contributed to 91% of the gains!
The bottom line is this:
If you invested in a S&P 500 index fund to diversify your risk and gain exposure to the broad market, you're not getting what you thought you were. The top heaviness of the index is exposing you to significant concentration risk.
Thankfully, there are other ways to invest in the S&P 500 besides the traditional market-weighted ETFs.
An alternative: equal-weight ETFs.
In an equal-weight ETF, each stock is given the same weight, regardless of its market cap. This means that smaller companies have the same influence on the index’s performance as larger ones.
That’s much different than index ETFs where the weight of each stock is determined by its market capitalization. (In simple terms, market cap is the value of a company calculated by multiplying its share price by the number of outstanding shares.)
Of course, neither ETF is perfect. Here are some pros and cons of each:
Equal Weighted S&P 500 Index ETF
More diversified, as it doesn’t rely on a few big companies for performance.
Provides better exposure to small and mid-cap stocks.
May outperform market-cap-weighted ETFs during specific market conditions, such as when smaller companies lead the market.
Higher portfolio turnover, as frequent rebalancing is required to maintain equal weights.
Typically higher expense ratios due to increased trading costs.
May underperform market-cap-weighted ETFs during periods when large-cap stocks dominate the market.
Market-Cap Weighted S&P 500 Index ETF
Dominant companies carry more weight, which can lead to better performance when large caps outperform small and mid-cap companies.
Tends to have lower turnover and lower expense ratios, which can save on trading costs.
Heavy concentration in large-cap stocks may lead to underperformance in specific market conditions.
Less diversified compared to equal-weighted ETFs, as a few big companies drive performance.
Which is the better performer?
The answer to that question depends on your timeframe. The equal-weight index performed better over the last 3 years. If you stretch that to 5 years, however, the market-cap weighted version is the winner.
When you look at long-term data, it’s a virtual tie, especially when you factor in transaction costs and management expenses.
Since 1971, which is how far back S&P Global has calculated the equal-weight version’s performance, the equal-weight version has produced a dividend-adjusted return of 12.2% annualized, in contrast to 10.8% for the cap-weighted version. But the equal-weight version’s higher return was produced with 13% more volatility, which is one measure of risk. On a risk-adjusted basis, the two are almost neck-and-neck, with equal-weight slightly ahead.
Why I prefer the equal weight index right now.
If the performance of both weighting styles is essentially the same, why am I pushing equal weight so much?
That’s a fair question.
It comes down to alignment with investor expectations.
Typically, when people invest in the S&P, they want risk diversification and exposure to the broad market. That’s not the case any more since the index is historically more top heavy than ever.
So, from an expectation standpoint, an equal-weight index gives investors more of what they’re looking for (i.e. diversification and broad market representation).
If you fall into this category, an equal-weight S&P 500 index ETF like the Invesco S&P 500 Equal Weight ETF (RSP) may be a better fit for you than the more-common SPY, VOO, or IVV, all of which are market-cap weighted.
But we can do even better with this style of ETF.
At The Antagonist, we’re not trying to simply match the return of the broad market. We want to crush it.
One way we can accomplish that is by weighting the S&P 500 according to business fundamentals.
For example, the investment research firm, Research Affiliates, tested a sales-weighted index going back to the 1970s. They found that if you select the 500 largest stocks by sales, and weight the index by sales, it outperforms the S&P by 2.5% per year for 30 years!
Factoring in other fundamentals will give you additional performance edges as well.
The challenge, however, is identifying which metrics give you the greatest advantage.
Thankfully, that work is done for us with just a single ETF. And that’s what my first recommendation is this month.
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