The S&P 500 is too tech heavy. This alternative ETF continues to beat it.

Investors love index funds for good reason. They allow for easy diversification and typically have low costs. For patient investors, broad-based index funds could outperform most actively managed funds because they are more expensive to manage and because it is so difficult to consistently select portfolios that beat the index.

But with the S&P 500 SPX returning 36.4% over the past year through September 30, warnings to investors tend to focus on two topics.

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The first is appreciation. The index trades at a price-to-earnings ratio of 21.6, based on Monday’s closing prices and weighted consensus earnings per share estimates among analysts surveyed by FactSet. That’s up from a price-to-earnings ratio of 18 a year ago, and well above the 10-year average price-to-earnings ratio of 18.3, according to data from FactSet.

The second warning concerns the concentration of the US large-cap benchmark index. The S&P 500 is weighted by market capitalization. On Monday, the portfolio of the SPDR S&P 500 ETF Trust SPY, the oldest and largest exchange-traded fund that tracks the index, was allocated 20% to three companies: Apple Inc. AAPL, Microsoft Corp. MSFT and Nvidia Corp. NVDA. These were the five largest holdings, which made up 26% of the portfolio:

SPY was founded in January 1993 and has $591 billion in assets under management.

All total returns in this article include reinvested dividends and net of fees.

The S&P 500’s market-cap weighting rewards success, but it can also lead index fund investors to concentrate more of their money in a handful of stocks than they may realize.

Different weightings and selection within the S&P 500

An obvious way to counter a capitalization-weighted index is to make an equal split. Because stock prices change daily, the Invesco S&P 500 Equal Weight ETF RSP is rebalanced quarterly. The equal weighting leads to a larger value shift, as the tech giants at the top of the index, with such strong revenue growth for a company like Nvidia, are all equally weighted, even for companies that are growing at a snail’s pace. This ensures differentiated performance. For example, in 2022, when SPY fell 18.2%, RSP fell only 11.6%. But when SPY roared back in 2023 with a 26.2% return, the RSP rose 13.7%.

The story continues

Invesco has several other alternative weighting methods for the S&P 500, and factor-based index tracking strategies that select within the index.

For a comparison of long-term performance, we limited the list to Invesco S&P 500 Factor ETFs founded more than five years ago. In addition to comparing the performance of the factor ETFs to SPY, we also compared them to the Vanguard S&P 500 ETF VOO, which was founded in September 2010 and has $509 billion in assets under management. SPY’s annual fees are s 0.0945% of average assets under management, while VOO’s expense ratio is 0.05%.

The following tables provide performance comparisons for SPY, VOO and nine of Invesco’s factor funds that have been around for more than five years. The first table shows the total return and the second table shows the average annual return.

The two broad S&P 500 index funds appear at the top of each table. Next up is the Invesco S&P 500 Quality ETF, as it is the only factor ETF that has been around for more than 15 years. The list is then sorted by five-year returns.

Each bold number for the factor ETFs means that the returns for that period were higher than those of SPY and VOO.

First, the total return:

And now the average annual return:

Unsurprisingly, VOO slightly beat SPY for all periods over 10 years, thanks to VOO’s lower costs.

Over the entire 15-year period, the Invesco S&P 500 Quality ETF SPHQ was the best performer. It has defeated SPY in all periods on the tables and has defeated VOO in all periods except the one-year period through September 30. SPHQ holds the 100 stocks from the S&P 500 that score highest based on a quality score that combines stock returns. equity, debt to book value and an accruals ratio of company assets to total assets. The indexes for all these ETFs are maintained by S&P Dow Jones Indices. The index tracked by this fund is rebalanced twice a year, with other adjustments made immediately following spinoffs or if a company is removed from the S&P 500. Each stock is weighted based on the product of its quality score and its market capitalization. SPHQ has a five-star rating (the highest rating) within Morningstar’s US Blend Large Fund category. The expense ratio is 0.15%.

The other notable outperformer among these S&P 500 factor ETFs is the Invesco S&P 500 Momentum ETF SPMO, which was founded in October 2015. It outperformed SPY and VOO over the one-, three- and five-year periods through September 30. The fund currently owns 99 shares of companies with the highest ‘momentum scores’. Twice a year, the components of the S&P 500 are ranked based on how much their prices have risen over the past twelve months, and then scored to account for volatility. The portfolio consists of the highest-scoring 20% ​​of companies in the S&P 500, and is then weighted by a combination of momentum score and market capitalization. This fund also has a five-star rating from Morningstar, within the investment information provider’s ‘US Fund Large Growth’ category. It has an expense ratio of 0.13%.

These factor ETFs “will shine brightest during different parts of the economic cycle,” said Nick Kalivas, head of Invesco’s factor strategy for exchange-traded funds.

During an interview with MarketWatch, he said that a particular advantage of the S&P 500 Momentum ETF is that it is less affected by broad market cycles, due to its weighting toward stocks that have performed well recently.

He added that a combination of indexing approaches “can be useful for portfolio management because they operate at different times” within market and economic cycles.

Here is a summary of the other seven listed Invesco factor funds, listing them in the same order as on the tables:

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