By Philip van Doorn, MarketWatch
Growth has beaten value in the stock market for many years.
But if you are feeling uncertain about the market — the trade standoff, Brexit, the health of the European Union, the threat of a recession and years of unprecedented stimulus by central banks — it may be time for you to diversify or consider a value-oriented strategy.
Diversification is not difficult. You can easily lower risk with an equal-weighted index fund or by selecting a value-oriented index fund.
There was a flurry of articles in the past week saying investors were reallocating to value strategies . Those articles were based on daily trading activity, which doesn’t mean much to long-term investors. But it’s a good time to assess the risk associated with index funds that are heavily weighted toward large, rapidly growing tech companies, and to look at how value stocks have performed through long periods.
Cap-weighted vs. equal-weighted
Most coverage of the broad U.S. stock market centers on the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.47% , which has performed well, aside from some short declines, since the post-financial-crisis bottom on March 9, 2009. This explains the incredible shift in assets into index funds and away from actively managed funds. But the S&P 500 is weighted by market capitalization, which means it is not really as diversified as you might expect it to be.
A list of the top 10 stocks (actually, nine companies because Alphabet has two common-share classes in the index) of the SPDR S&P 500 ETF /zigman2/quotes/209901640/composite SPY +0.40% as of the close on Sept. 11 illustrates this top-heaviness:
|Stock||Ticker||Share of portfolio||Total return - 5 years|
|Microsoft Corp.||/zigman2/quotes/207732364/composite MSFT||4.20%||224%|
|Apple Inc.||/zigman2/quotes/202934861/composite AAPL||3.81%||140%|
|Amazon.com Inc.||/zigman2/quotes/210331248/composite AMZN||3.03%||452%|
|Facebook Inc. Class A||/zigman2/quotes/205064656/composite FB||1.80%||142%|
|Berkshire Hathaway Inc. Class B||/zigman2/quotes/200060694/composite BRK.B||1.62%||53%|
|JPMorgan Chase & Co.||/zigman2/quotes/205971034/composite JPM||1.53%||123%|
|Alphabet Inc. Class C||/zigman2/quotes/205453964/composite GOOG||1.49%||110%|
|Alphabet Inc. Class A||/zigman2/quotes/202490156/composite GOOGL||1.45%||106%|
|Johnson & Johnson||/zigman2/quotes/201724570/composite JNJ||1.38%||44%|
|Visa Inc. Class A||/zigman2/quotes/203660239/composite V||1.23%||237%|
|SPDR S&P 500 ETF||SPY||66%|
So over the past five years, eight of the 10 stocks have outperformed SPY. Then again, that’s a very small group of companies making up more than a fifth of your “diversified” investment in the S&P 500. (SPY is the oldest exchange traded fund that tracks the S&P 500, and the largest, with total assets of $256.7 billion.)
You can reduce your risk when investing in the entire S&P 500 by going with an equal-weighted index fund, such as the Invesco S&P 500 Equal Weight ETF /zigman2/quotes/202854823/composite RSP +0.55% . With several rapidly growing tech companies dominating the S&P 500, it’s reasonable to expect historical performance of the equal-weighted ETF to trail the cap-weighted index and SPY, but it’s worth taking a second look:
|ETF||Ticker||Total return - 2019 through Sept. 11||Total return - 3 years||Total return - 5 years||Total return - 10 years||Total return - 15 years|
|SPDR S&P 500 ETF Trust||/zigman2/quotes/209901640/composite SPY||21.3%||49%||66%||250%||260%|
|Invesco S&P 500 Equal Weight ETF||/zigman2/quotes/202854823/composite RSP||20.9%||40%||53%||249%||293%|
The equal-weighted approach has trailed in four of the five periods shown. However, it is only slightly behind the cap-weighted approach this year, and has solidly beaten SPY for 15 years. Annual expenses for SPY are 0.09% of assets, while the expense ratio for RSP is 0.20%.
Value over growth?
The Russell 1000 Index /zigman2/quotes/210598144/delayed RUI +0.39% is another cap-weighted benchmark. It represents about 90% of the U.S. stock market by holding shares of the largest companies.
FTSE Russell divides the Russell 1000 into two overlapping groups: The Russell 1000 Value Index /zigman2/quotes/210598148/delayed RLV +0.46% which includes 760 companies in the Russell 1000 that have lower price-to-book ratios and lower expected growth rates, while companies with a combination of lower composite value score and higher expected growth rates are included in the Russell 1000 Growth Index /zigman2/quotes/210598136/delayed RLG +0.33% , which has 526 companies. There are 288 companies that are in both the value and growth indexes. FTSE Russell describes the makeup and scoring for all its indexes here .