March 2022 Market Commentary

 Beware the Growth Bias in the S&P 500 Index

After several years of Growth stocks dominating Value stocks, the S&P 500 Index may no longer be the “broadly diversified” benchmark investors have relied upon to track the market. With the largest companies in the S&P 500 Index carrying an undue load, investors may be exposed to unexpected risks; a “set it and forget it” strategy that has been successful in the past may not be advisable for those invested in or tracking index funds.

Growth/Value Style is Out of balance

On the surface, when looking at the style boxes on Vanguard’s website for its S&P 500 Index ETF VOO and Fidelity’s website for its 500® Index Fund FXAIX, both companies highlight the “Large Blend” category. See below images with the red box for Vanguard’s VOO ETF and blue box for Fidelity’s FXAIX fund. 

Because both Vanguard and Fidelity source the “style” information from Morningstar, one would expect to get the same results directly from Morningstar. Here are the Map and Weight versions of Vanguard’s VOO ETF which paint a more detailed picture. 

While the centroid falls within the “Large Blend” box, there is a clear tilt to Large Growth. By looking at the percentages, the Large Growth weighting is double the Large Value allocation at 40% compared to 20%, respectively. Value and Growth styles have different risk/return profiles and, historically, most passive investors seek out style neutral funds because tilting to Growth or Value would signify an “active” bet. With index weightings today tilting toward a Growth style, index fund managers are forced to follow in lockstep, which may not be aligned with passive investors’ objective to remain style neutral.  

Technology is Carrying an Unbalanced Load

The majority of this Growth bias comes from the Technology sector, which weighs in at 28.5% of the S&P 500 Index. This is after the sector reclassification in 2018, when Alphabet (Google) and Meta Platforms (FaceBook) were removed from the Technology sector and added to the Communication Services (formerly Telecommunications) sector. Including these two companies would bring the adjusted technology weighting to 34.5%. As a comparison, this would exceed the 33% technology weight reached at the height of the 1999 tech bubble before it fell out of favor.

S&P 500 Index is Top-Heavy

The largest six companies represent about 25% of the Index, with Apple and Microsoft at 7.1% and 6.1%, respectively, as of 1/31/2022. 

So, while there are roughly 500 companies that make up the index, the top six holdings dominate it. This concentration adds company risk to the index, which exceeds that of the late ‘90s tech boom and hasn’t been this top heavy since the early 1970s, when investing in the “Nifty 50” was fashionable. This contrasts with one of the main hallmarks of a broad index, which is to diversify away individual company risk.

Given the Growth style bias, technology overweight and concentrated holdings of the S&P 500 Index, we encourage index investors to review the individual stock holdings of their funds to accurately assess their portfolio risks. We utilize services from Morningstar’s Portfolio X-Ray and Y-Charts to provide this company-level detail for monitoring and managing client portfolios. To reduce the Growth exposure in the S&P 500 Index, Value funds could be used as a complement – in the right proportions – to achieve a style neutral portfolio. However, owning a portfolio of individual stocks allows for greater transparency and flexibility to manage the style, sector and company risk when compared to funds. 

Resources:

Vanguard S&P 500 ETF (VOO): https://www.morningstar.com/etfs/arcx/voo/quote

Fidelity 500 Index Fund (FXAIX): https://www.morningstar.com/search?query=FXAIX