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 usually have low overhead. For patient investors, broad-based index funds may outperform most actively managed funds because that management is more expensive and because it’s so difficult to select consistently winning portfolios.

But with the S&P 500 SPX having returned 36.4% in the past year to Sept. 30, warnings to investors typically focus on two topics.

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

The second caveat concerns the concentration of the US large-cap benchmark. The S&P 500 is weighted by market capitalization. On Monday, the SPDR S&P 500 ETF Trust SPY Portfolio, the oldest and largest exchange-traded fund that tracks the index, had a 20% allocation to three companies: Apple Inc. AAPL, Microsoft Corp. MSFT and Nvidia Corp. NVDA. These were his top five holdings, which accounted for 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 are net of expenses.

The market-cap weighting of the S&P 500 rewards success, but it can also lead to index fund investors having more money concentrated in a handful of stocks than they might realize.

Different weightings and selection within the S&P 500

An obvious way to counter a maximum-weighted index is to allocate equally. Because stock prices move daily, the RSP of the Invesco S&P 500 Equal Weight ETF is rebalanced quarterly. Equal weighting leads to greater value skew because the tech giants at the top of the index, with such strong sales growth for a company like Nvidia, are all equally weighted, even for companies growing at a snail’s pace . This ensures differentiated performance. For example, in 2022, when SPY fell 18.2%, RSP only fell 11.6%. But when SPY returned 26.2% in 2023, RSP rose 13.7%.

The story continues

Invesco has several other methods for alternative weights to the S&P 500 and factor-based strategies to track indices that select from within the index.

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

The following tables have 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 returns and the second table shows the average annual returns.

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

Any number in bold for factor ETFs means that its return for that period was higher than that of SPY and VOO.

First, total returns:

And now, the average annual return:

Not surprisingly, VOO has easily beaten SPY for all periods since the 10 year, due to VOO’s lower expenses.

For the entire 15-year period, the Invesco S&P 500 Quality ETF SPHQ was the best performer. It beat SPY for all periods on the tables and beat VOO for all but the one-year period to September 30. SPHQ holds the top 100 stocks in the S&P 500 based on a quality score that combines returns on equity, debt/book value and a “commitment ratio” of operating assets to total assets. The indices for all these ETFs are maintained by S&P Dow Jones Indices. The index tracked by this fund is rebalanced twice a year, with further adjustments made immediately after spinoffs or if a company is removed from the S&P 500. Each stock is weighted by the product of its quality score and its market capitalization. SPHQ is rated five stars (highest rating) in Morningstar’s US Blend Large Fund category. Its expense ratio is 0.15%.

The other notable performer among these S&P 500 ETFs was the Invesco S&P 500 Momentum ETF SPMO, which was established in October 2015. It outperformed SPY and VOO for the one-, three-, and five-year periods through September 30. the fund currently holds 99 stocks of companies with the highest “momentum scores.” Twice a year, S&P 500 components are ranked by how much their prices have risen over the past 12 months, then scored to account for volatility. The portfolio consists of the top 20% of S&P 500 companies, then weighted by a combination of momentum score and market capitalization. This fund also has a five-star rating from Morningstar in the investment information provider’s “US Fund Large Growth” category. It has an expense ratio of 0.13%.

These factor ETFs “will shine brightest in different parts of the economic cycle,” according to Nick Kalivas, who leads Invesco’s factor strategy for exchange-traded funds.

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

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

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

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