Market-cap vs equal-weight: Which S&P 500 wins from here?

The S&P 500 has rewarded Australian investors handsomely over the past decade, returning about 15.5% per annum on an unhedged basis.

The index has become so popular that it's even spawned its own investing mantra. On Reddit, US investors talk about "VOO and chill" – building an entire portfolio around Vanguard's S&P 500 ETF (NYSE: VOO). In Australia, the equivalent has become "IVV and chill", referring to the iShares S&P 500 ETF (ASX: IVV).

Yet beneath those stellar returns lies a growing concentration risk. Today, the top 10 stocks account for around 36% of the S&P 500, well above the long-term average of 23%, while the Magnificent Seven have contributed an estimated 40-60% of the index's gains since late 2022.

That naturally raises a question for investors.

Should you continue backing America's biggest winners through a traditional market-cap weighted ETF, or switch to an equal-weight strategy that gives each company in the S&P 500 roughly the same allocation? The latter owns the same 500 businesses, but instead of Apple, Microsoft and Nvidia dominating the portfolio, every company starts at around a 0.2% weight.

We asked three investment professionals how they'd approach the S&P 500 if they were investing $100,000 today.

Sebastian Ferrando: Why not both?

Over the very long haul, equal-weight has delivered a modest performance edge over the market-cap approach, as shown in the chart below.

But the past decade has rewarded concentration, with equal-weight lagging the traditional S&P 500 by four percentage points per annum (11.5% p.a. vs 15.5% p.a).

If Koda Capital's Sebastian Ferrando had to allocate fresh money today, he'd split it between the two.

One of Livewire's strongest advocates of the S&P 500 as a long-term growth investment, Ferrando believes equal-weight deserves a place alongside traditional market-cap exposure.

His reasoning starts with perspective. While investors often worry the US market has become too concentrated, Ferrando notes it's actually one of the least concentrated major equity markets globally (see below).

"In the 25 largest markets on the planet, the average top 10 concentration is 67%, it's well over 60% in Australia, and the US is below 40%," he says.

More importantly, he argues concentration has been earned.

"Over time, valuations almost always follow one thing, and one thing only – earnings. The reason the Mag 7 stocks have risen the most is because they have contributed the most to earnings, and to the growth in earnings."

That makes him reluctant to reduce exposure to the companies driving America's economic growth.

"There's no point missing out on a 50% rally to avoid a 20% decline."

Ferrando is also quick to point out that two things can be true at once. Market-cap weighting gives investors greater exposure to the fastest-growing part of the US market, while equal-weight reduces concentration risk.

"I’m already splitting exposures (and by how much is specific to the individual client), the continuing strong earnings from the top of the market cap table, but layered with a broadening of earnings. That’s kind of happening as we speak," he says.

In terms of diversifying away from the S&P 500 itself, Ferrando doesn't see much value in doubling up on quality growth. Instead, he prefers adding assets that perform different roles within a portfolio:

• Traditional fixed income to reduce volatility.
• Private credit to enhance portfolio income.
• Infrastructure for stable, long-term growth.
• Cash to provide liquidity and flexibility.

Hugh Lam: Equal-weight shines when market breadth improves

Betashares investment strategist Hugh Lam agrees market-cap weighting has deserved its outperformance over the past decade, but he believes history suggests periods of extreme concentration rarely last forever.

He points to three previous periods when equal-weight outperformed its market-cap counterpart: 

• 2001-06: Following the dotcom bust, leadership rotated away from the largest technology stocks towards value sectors.
• Post-GFC to 2014: Fiscal stimulus and ultra-low interest rates fuelled a recovery in smaller and more cyclical companies.
• 2021-22: The post-pandemic reopening and rising interest rates broadened market leadership beyond mega-cap growth, with value and energy outperforming.

This is supported by the following chart, which shows the ratio of the S&P 500 market cap weighted index relative to the equal weight index. A fall in the line chart represents equal-weight outperformance.

"Across all three periods discussed, the S&P 500 equal weighted approach outperformed its market cap variant when concentration unwound and market breadth improved," he says.

Lam also points out that equal-weight doesn't invest in different companies - it simply weights them differently.

For example, in the Betashares S&P 500 Equal Weight ETF (ASX: QUS), the Magnificent Seven account for just 1.4% of the portfolio, compared with roughly one-third of a traditional market-cap weighted S&P 500 ETF. The result is greater exposure to sectors such as industrials, financials and consumer discretionary.

Like Ferrando, Lam sees merit in holding some equal-weight exposure at this stage of the cycle. It could outperform if earnings growth broadens beyond technology, mega-cap valuations compress or cyclical sectors reclaim market leadership.

At the same time, insurance is rarely free. Investors who materially reduce their exposure to market-cap weighting also risk owning too little of the companies that have driven both earnings growth and market returns over the past decade.

"Over the past three calendar years, the cost of not owning them was enormous with the Magnificent 7 returning 75%, 64% and 23% respectively from 2023-2025 so underweighting these companies meant an investor would have materially lagged the S&P 500 index," Lam says.

Lam also sees value in blending the two approaches, with the mix ultimately depending on how much exposure an investor wants to the market's biggest growth companies versus the diversification benefits of equal-weight.

For investors looking to diversify beyond a traditional S&P 500 ETF, or simply rebalance their overall US equity exposure, Lam suggests complementing it with:

• Betashares Developed Markets ex-US ETF (ASX: EXUS) for exposure to Europe and Japan.
• Betashares Emerging Markets ETF (ASX: BEMG) to diversify earnings drivers beyond the US.
• Betashares Global Quality Leaders ETF (ASX: QLTY), which targets companies with strong balance sheets, high returns on equity and resilient earnings.

Adam Dawes: There is one clear choice

If the other two are hedging their bets, Shaw & Partners Senior Investment Adviser Adam Dawes isn't.

"If I had to pick one, I'd still go with a traditional market-cap S&P 500 ETF. It keeps you invested in the biggest and most profitable companies driving growth in the US."

"The mega-cap technology companies remain highly profitable, cash generative and central to themes such as AI, cloud, semiconductors and digital advertising."

That view was vindicated overnight when Micron's (NASDAQ: MU) shares jumped 15% in the pre-market after the company reported fiscal third-quarter revenue had more than quadrupled, from US$9.3 billion to US$41.46 billion, underscoring just how much money continues to flow into the AI story.

For Dawes, the biggest misconception is that equal-weight is simply a lower-risk version of the S&P 500.

"I would describe equal-weight as a rotation strategy, not simply a lower-risk strategy. It is a bet that the next phase of returns will be broader than the last phase," he says.

"Equal weighting reduces single-stock concentration, but it doesn't remove risk - it just shifts it."

By increasing exposure to smaller and mid-sized companies while trimming the market's biggest winners, equal-weight can outperform if leadership broadens or valuations mean revert. But it can just as easily lag if large-cap companies continue delivering superior earnings growth.

Rather than replacing market-cap exposure, Dawes prefers building around it. His suggested portfolio additions include:

• Global X Russell 2000 ETF (ASX: RSSL) for exposure to US small-cap companies.
• Vanguard All-World Ex-US Shares ETF (ASX: VEU) to diversify beyond the United States.
• Plato Global Shares Income Fund (ASX: PGI2) for dividend income and stronger balance-sheet companies.
• International bonds to provide income and portfolio ballast during periods of market weakness with Vanguard International Fixed Interest (Hedged) ETF (ASX: VIF) being among the top picks.

His message is straightforward: don't abandon America's biggest winners, but don't let them become your entire portfolio.

The verdict

None of the three experts argued investors should abandon the traditional S&P 500. Instead, they differed on how to manage its growing concentration.

Ferrando prefers combining market-cap and equal-weight exposure. Dawes keeps market-cap as the core while diversifying around it with small caps and international assets. Lam believes equal-weight deserves greater consideration as market leadership broadens.

The takeaway for investors is that concentration isn't necessarily something to fear. But whether through equal-weight ETFs, global diversification or defensive assets, relying on a single source of returns may prove to be the bigger risk over the next decade.